Westpac to pay $9.8m for ‘unconscionable conduct’ over $12b rate swap deal in 2016

Westpac Banking Corporation (ASX: WBC) has been found to have engaged in unconscionable conduct over a mammoth $12 billion interest rate swap transaction in 2016, with the Federal Court ordering the big-four bank to cough up $9.8 million in costs and penalties.

The interest rate swap transaction, with a consortium comprising AustralianSuper and IFM entities, was the largest of its kind in Australian financial market history and scored Westpac a $20.7 million profit in a single day.

An interest rate swap is an agreement between two parties to exchange one stream of interest payments for another.

The Federal Court found that Westpac’s unconscionable conduct arose when it engaged in pre-hedging ahead of the transaction which related to managing interest rate risk associated with the consortium’s purchase of a majority stake in electricity provider Ausgrid from the NSW Government.

The pre-hedging led to Westpac’s derivatives trading desk making a trading profit of about $20.7 million on the day the swap was executed, of which $3.7 million was allocated to its sales team as commission.

The Federal Court has ordered Westpac to pay the maximum penalty of $1.8 million following its ruling, along with $8 million for litigation and investigation costs incurred by the Australian Securities and Investments Commission (ASIC).

“This is a significant outcome which assists to clarify expectations regarding pre-hedging, particularly around disclosure and consent where the pre-hedging can have a detrimental impact on the counterparty to the transaction,” says ASIC’s deputy chair Sarah Court.

“Appropriate conduct for pre-hedging is an issue of global significance.

“In this case, Westpac’s behaviour was unconscionable and exposed its client to significant risk. Westpac’s conduct was also in stark contrast with several other banks.

“We share the court’s concern regarding the maximum penalty available in relation to the conduct, and note that had Westpac engaged in similar conduct today the maximum available penalty would have been significantly higher.”

Civil penalties have become more punishing since 2016 with the current penalty for unconscionable conduct in breach of the ASIC Act being at least $15.65 million for a corporation.

The maximum penalty for a large entity, such as Westpac, could potentially be $782.5 million or three times the benefit derived, whichever is greater.

Among the key findings by the Federal Court is that Westpac was aware of its client’s concern about trading prior to the swap transaction, known as pre-hedging, that had the potential to adversely affect the price of the swap transaction to the client's detriment.

Every basis point increase to the price of the swap transaction would involve a cost to the consortium of about $4.7 million.

ASIC says that despite being aware of its client’s concerns, Westpac acted on an internal plan to pre-hedge up to 50 per cent of the interest rate risk by trading in significant volumes of interest rate derivatives in the market before the swap transaction was executed.

ASIC says that Westpac failed to obtain client consent or give clear and full disclosure about the extent of its planned pre-hedging.

Once Westpac began its on-market pre-hedging trading, it says the consortium could not protect itself against the risk that Westpac’s trading would increase the price of the swap transaction.

“If pre-hedging is not carried out in an appropriate manner it can be unfair, unconscionable and result in poor client outcomes,” says Court. “We will continue to hold participants in these markets to high standards.”

The Federal Court declared that Westpac failed to have adequate arrangements to manage the conflict of interests between the bank and the consortium.

It also found that Westpac did not do everything necessary to ensure that the swap transaction was provided to the consortium 'efficiently, honestly and fairly'.

The court has reserved its decision on whether to make an order requiring Westpac to complete a compliance program with an independent review of its pre-hedging practices and controls, including relating to conflicts of interest management and client communications.

Westpac says that since 2017 it has made significant enhancements to its arrangements to manage conflicts of interest.