Key determination 1: Foreign exchange trading
The financial services provider (FSP) was a foreign exchange broker that provided online trading facilities for, among other things, foreign exchange trading. The applicant disputed the reversal by the FSP of $125,000 of USD/CNH (US to Chinese currency) trades placed over a seven day period.
The client agreement set out the terms of the contract
The contract terms were contained in a client agreement. It included a clause titled ‘Error in Pricing’ and permitted the FSP to void a margin FX contract or CFD from the outset if there had been a ‘material error.’ A ‘material error’ was where the pricing by the FSP was materially incorrect when taking into account market conditions and quotes in the underlying instruments which prevailed at the time.
The error was in the swap rate
The FSP said the material error was in the swap rates that were applied, in particular over the Chinese New Year holiday. The FSP said that the error was evident given the swap rate deviated significantly from the market swap rate.
The applicant considered material errors were limited to automated errors
The applicant believed that the ability to reverse a trade for a material error was meant for pricing errors that were caused automatically by an unorderly market, such as a previous market event that occurred with the Swiss franc. It could also arise from a price feed from one if its liquidity providers providing erroneous prices.
The applicant also considered the ability to reverse trades was intended to capture trades that occur before the error could be noticed and corrected. The applicant’s trades remained honoured for a number of days.
The Panel noted that ‘material error’ as defined in the contract referred to errors, omissions or misquotes in the pricing of a foreign exchange contract. An error in the swap rate led to an error in the pricing of the foreign exchange contract. The Panel considered an error in the swap rate was therefore covered by the contract.
The FSP was a market maker with a history of volatile rates
The Panel found the FSP was a market maker in swap rates. The FSP also had a history of volatility in its swap rate compared to prevailing market rates. As such, the fact the FSP’s swap rate deviated from the market rate was not persuasive that there was a material error. The FSP also did not explain how the raw data it produced translated to a pricing error, particularly given the FSP’s status as a market maker.
Further, foreign exchange markets trade continuously, which was a feature highlighted in the FSP’s product disclosure statement. The FSP did not have an obligation to quote prices or accept orders during Chinese New Year when the markets were closed. It chose to do so.
Accordingly, the Panel found the FSP had not established there was a material error on which it could rely to reverse the trades. The FSP was therefore required to compensate the applicant $125,000.
Key determination 2: Misleading conduct
This determination found that the financial services provider (FSP) misled the applicants about the cost of fixing their home loan interest rate for 10 years.
In 2008, the applicants obtained a loan from the FSP for $205,000 over 30 years. For the first 10 years, the interest rate was fixed.
The applicants say that before they signed the loan contract in 2008, the FSP told them:
- they could switch the loan to a variable rate before the expiry of the fixed period without paying break costs, as long as the variable rate was above or equal to the fixed rate and
- if the variable rate started coming down, they would have time to switch to a variable rate without incurring a break cost, because the variable rate was over 1% per annum above the fixed rate.
The applicants subsequently noticed a movement in interest rates and sought to convert the loan to a variable interest rate. They were told by the FSP that they would incur a break cost of approximately $50,000 to do so.
The applicants lodged a dispute at FOS saying that they had been misled by the FSP about the ramifications of fixing their interest rate and how the break cost calculation worked.
FOS can investigate misleading conduct claims
Under the ASIC Act, a person must not engage in conduct in relation to financial services that is likely to be misleading or deceptive.
Misleading conduct may occur where a financial services provider made a misleading statement or where a financial services provider remained silent about a particular matter, in circumstances where an explanation was called for.
To establish misleading conduct, an applicant generally must show:
- the financial services provider made a representation that was likely to be misleading
- the applicant reasonably acted in reliance on that representation, and
- in relying on that representation, the applicant has suffered a loss.
The applicants acknowledged receiving the terms and conditions
The applicants agreed that in 2008 they received and read the loan contract, the terms and conditions and a brochure provided by the FSP titled ‘early repayment of fixed rate loans’. The terms and conditions say that a break cost is payable if the FSP suffers a loss due to changes in market interest rates. That break cost can involve a complex calculation using variables such as the FSP’s cost of funds. The applicants said they read the loan documents and brochure, but found it difficult to understand.
The Ombudsman formed the opinion that the information in the documents provided to the applicants and their experience with a previous fixed rate loan, meant that they should have been aware that break cost calculations were complex and required calculations based on a number of variables on any given day.
It is clear the parties discussed fixed rate loans prior to signing the loan contract
The applicants provided clear and consistent statements of their recollection of discussions with the FSP prior to signing the loan contract in 2008. The available information showed that they were concerned about fixing their interest rate and incurring break costs as they had paid a break cost before. It was also clear they were concerned about rising interest rates and the impact that would have on their ability to afford the repayments.
The Ombudsman reviewed the credit assessment undertaken by the FSP in late 2007 and determined that the applicants’ income and expenses meant that affordability was tight. Therefore the applicants knew that any rise in interest rates would place a great deal of pressure on them to meet their monthly repayments.
The FSP staff member involved in this dispute acknowledged he did not recall the specifics of the discussion with the applicants in late 2007 or early 2008. Rather, he referred to what he considered to have been his usual practice at the time. He did recall that one of the applicants was concerned about rising interest rates at the time.
The Ombudsman determined that in all the circumstances the applicants’ recollections were to be preferred. On that basis he was satisfied the applicants approached Mr B to discuss fixing their interest rate and to gain a better understanding of what might be involved if they sought to break the fixed rate loan at any time.
Based on all the available information and surrounding circumstances, the Ombudsman was satisfied that the misleading conduct had been established and the applicants relied on the FSP statements above to fix their interest rate for 10 years.
Fixing the interest rate on a loan for 10 years can have serious consequences
The Ombudsman acknowledged that the ramifications of fixing the interest rate on a loan contract can be serious, particularly for a 10 year period. Accordingly FOS expects there will be an adequate and proximate disclosure of the risks associated with the transaction by the FSP. Any discussion about the fixed rate products between the FSP and its customer has to be comprehensive and sufficiently illuminating to allow them to make an informed decision. The discussion should also be documented with appropriate notes by the FSP.
In the circumstances of this dispute, there was no record of the discussions with the applicants in late 2007 or early 2008 about obtaining a fixed rate loan. The Ombudsman noted that, given it is clear the applicants did get a fixed rate for 10 years, this was a surprising omission in the FSP’s records and falls short of good industry practice.
The Ombudsman arrived at a fair outcome
As the applicants were concerned about rising interest rates in 2008 and the serious impact it would have on their budget, the Ombudsman determined that it was more likely than not that, if the FSP had given a comprehensive response to their queries, the applicants would have exercised greater caution and only fixed their interest rate for five years.
The Ombudsman obtained a calculation from a FOS Industry Specialist who re-cast the applicants’ loan as if it had only been fixed for five years in 2008 and switched to variable in 2013. The FSP was required to reduce the loan balance accordingly. The applicants were provided with a variable rate home loan and no longer faced the prospect of paying break costs if they repaid the loan.