A great deal of speculation is rife about the possibility of negative interest rates and the impact that this could have upon a range of services – those of solicitors included.
The Bank of England has this month warned High Street lenders that they should prepare for negative interest rates in the next 6 months whilst at the same time ruling out an imminent move to them. Is this something that is likely to happen and should solicitors also be taking steps now to deal with the threat of negative interest? In reality, negative interest rates are something that the Bank of England is likely to resist for as long as possible. As the Guardian said of the Bank of England on 4th February 2021 “Not once since it was founded in 1694 have interest rates gone negative and there is no immediate prospect of that 327-year-long record ending”. However, lots of things have happened in the past five or six years that we could never have predicted!
What does “negative interest rates” mean?
When we talk about “interest rates” in this context, what we are actually talking about is the Bank of England base rate which is the base rate that sets out how much interest the Bank of England will pay to financial institutions that hold money with it and indeed what it will charge those institutions to borrow from it. Therefore, it does not necessarily mean the interest rate that will be passed on to borrowers and investors and individual financial institutions may decide either to pass on or not pass on the costs of that negative rate.
Lower interest rates are something that the Bank of England uses when it wants people to spend more and save less and March 2020 saw a reduction of interest rates from 0.25% to a new low of 0.1% (the second in just over a week – the rate having just been cut from 0.5%) as the Bank of England attempted to stimulate the economy in the face of the COVID-19 pandemic. One of the Bank of England’s main imperatives is to ensure that prices rise by a stable rate of inflation (ideally 2%) so as to keep the economy rising. Whilst low inflation means that prices do not go up, it can also mean that wages do not go up either and this can have a negative impact upon consumer confidence and spending.
Interest rates have gone, and are currently, below zero in other economies including Sweden, Switzerland and Japan – dropping to -0.75% in Switzerland. Banks in those countries that have seen sub-zero rates have in many cases passed those rates onto larger investors but have been reluctant to pass the rates on to smaller businesses and individuals because doing so would make the bank less competitive and, despite the low interest rates, they all still all fighting for the same accounts.
Whilst there is a possibility that Banks might stop paying interest on savings accounts, therefore – and let’s face it, the rates that they are currently paying are so low that they might as well not bother sometimes – it doesn’t necessarily mean that those who borrow money are going to be paid by the bank for doing so.
Take mortgages, for example. A large proportion of mortgages currently are fixed rate mortgages and these will not be affected as the fixed rate will continue to apply even though interest rates have changed – that is their attraction, that they will not go up if interest rates rise. Variable rate mortgages on the other hand could, however, fall a little if the base rate is cut although the practical likelihood is that any drop will be limited by terms and conditions of the mortgage which may have a minimum rate set – for example always 1% above base rate. Some other countries have seen mortgages with negative interest rates – for example in Denmark, borrowers with Jyske Bank were offered a rate of -0.5% which resulted in the sum they owed to the bank falling each month by a larger amount than that which the borrower had paid.
Implications for Solicitors
Aside from the wider implications of mortgages possibly becoming cheaper and therefore there being an increase in conveyancing work, the impact that negative interest rates could have upon solicitors and law firms will depend mainly upon what the banks decide to do in relation to the client accounts that firms have with them.
If the banks decide to maintain solicitor client accounts at or above zero then all that will happen will be that those accounts will either not earn interest, or earn very little interest, and that as a result there will be little or no interest that the firm can retain (if it is appropriate to do so) or pass on to the client. This is a situation that firms have become used to over the past few years with the heady days of bank accounts providing a source of profit to firms long gone. Managing client account now is most certainly a loss-making activity for most firms, something that is compounded by the growth in the number of regulations to which solicitors are subject as a result of holding such accounts.
However, if the banks were to decide that money held in client account should be at a negative rate of interest then there is the spectre of firms needing to consider that they will be charged for holding client money. That may not, of course, come to pass and even with negative interest rates the banks might choose not to make a charge. Equally, however, they might or, even more confusingly for firms, some might and other might not meaning that firms will need to monitor the situation and may need to consider moving accounts depending upon what each bank decides to do.
So, if it were to happen that banks did start to apply negative interest rates to client accounts, could solicitors pass on to the client the costs of holding money in that account. Although no official view has as yet been expressed on the Solicitors Regulation Authority (SRA) website, it is understood that the view currently taken by the SRA is that costs could not be passed on and would have to be absorbed by firms. In a report published by Legal Futures (https://www.legalfutures.co.uk/latest-news/sra-may-not-allow-firms-to-recharge-cost-of-negative-interest-rates) a SRA spokesperson speaking at the virtual conference on the Institute of Chartered Accountants in England & Wales’s solicitors group said that in his view the SRA would “probably say no” to whether charging would be allowed, although no decision had at that time been made. He stated that “it’s not in the client’s interest to pick up the cost of the economy.” He added that the SRA would issue guidance if necessary – although whether that guidance would be issued quickly enough for firms to take appropriate steps remains to be seen.
The same Legal Futures article quoted the Law Society on the topic. They apparently are waiting to see what the regulator does. It’s good to know they have our backs!
What do the Standards and Regulations say?
Of course, just because the SRA informally take the view that solicitors could not pass on the cost does not, of itself, make it so. There would have to be some basis behind what they say.
Unfortunately, this means that we are thrust back on the rather vague requirements contained in the Accounts Rules and, to a lesser extent, the Codes of Conduct and the Principles.
The relevant provisions of the Accounts Rules are to be fund at Rule 7: Payment of Interest. This provides:
Rule 7.1 does not offer a great deal of comfort in this since its wording does not encompass the concept of negative interest. On the other hand, neither does it specifically say “positive” interest so, if interest can be negative then perhaps the payment of a sum to clients can be negative also – in other words a charge. Difficult to argue, perhaps.
Rule 7.2 may be of more help, however, since it shows that different arrangements can be reached, probably on a case-by-case basis, by a written agreement with a client who has given “informed consent”. Whether it would be sufficient for a term to be inserted in a firm’s terms and conditions is open to some doubt. However, perhaps if a clear explanation were to be prominently provided in the firm’s client care letter then that would be enough – even possibly going so far as to get clients to sign an agreement to the fact that charges will be made in such circumstances. There are, of course, downsides to this approach. Inevitably extra work would be created for the firm which might easily offset any financial benefit that a payment would give. Also, it is not necessarily a particularly good marketing point for a firm that is in competition with other firms, many of whom might not be passing on the cost. So, this is something firms will need to make a commercially considered decision upon.
However, all may not be lost. The provisions of paragraph 8.8 of the Code of Conduct for Solicitors, RELs and RFLs states that solicitors ensure “that any publicity in relation to your practice is accurate and not misleading, including that relating to your charges and the circumstances in which interest is payable by or to clients”. Clearly the payment of interest by clients is envisaged – even if it is probably here in relation to unpaid costs. Why then, should clients not refund interest paid?
The statement by the SRA implies that charging the client interest is not in their best interests and, of course, Principle 7 does require that firm’s act “in best interests of each client”. The danger with accepting that argument, however, is that charging a client a fee is not necessarily in the best interests of the client, but no one is advocating that firms act on a permanently pro bono basis. It also depends upon how you interpret “in the best interests”. It is no one’s best interests – firm or clients – for the firm to be uneconomic or go out of business.
However, it also depends upon how a negative interest rate is dealt with by the banks. If the bank, rather than applying a negative interest rate to an account decides instead to apply a charge by way of a fee then, depending upon how that charge is made, it is possible that such a charge could be regarded as a disbursement. A disbursement is defined in the Glossary to the Standards and Regulations as “any costs or expenses paid or to be paid to a third party on behalf of the client or trust (including any VAT element) save for office expenses such as postage and courier fees.” Provided that the firm was open and transparent about what the payment related to, and this was clearly disclosed in any Transparency Rule related information, then there is an argument for regarding such payments, probably only those that could be attributed to a particular account – as a disbursement.
A further way to address the issue is simply to increase fees so as to cover the costs that have to be paid. Again, in a competitive market this may not be something that is open to the firm.
What should solicitors’ firms be doing?
Until such time as it is clear as to whether there will be negative interest rates and whether these will be passed on by the banks to those holding money with them, then there is probably not a great deal that can be done.
Some have advocated that firms that are concerned might want to consider moving to a Third-Party Managed Account (TPMA) where the firm can then simply pass on the costs associated with the management of that account to the client. This is a complex solution to the problem, and not one that will necessarily appeal to many firms due to the costs of operating in this way.
Probably the only steps that firms need to take at present is to buy themselves some flexibility in the future – since we don’t know that that future holds – and to keep an eye on that which each bank plans to do so that they can, if necessary and expedient, move an account to a different bank. In addition, they may also be wise to reserve to the firm, in its terms and conditions, the right to change the basis on which it pays interest. Possible wording could be along the lines of:
“In the event that any bank with which we place client funds should notify us of their intention to apply negative rates of interest to that account, then {Firm Name} reserves the right to revise the terms upon which it pays and or charges interest in accordance with the Solicitors Accounts Rules 2019. Should any such change materially prejudice any client or their case or transaction then that client will be informed of the change as soon as is reasonably practicable.”