Greece’s travails have led to much recent speculation about the impact on its banks, creditors and bond markets in the coming weeks and months. But the uncertainty that has surrounded the stricken country for some time may already be storing up trouble for UK-based banks in areas beyond their limited sovereign debt holdings. One such area is an anticipated rise in disputes over Euro-linked foreign exchange derivatives contracts, a US$750 billion per day market globally.
Lessons from the 2008 financial crisis
One feature of the last financial crisis was an unprecedented shift in foreign exchange rates in a number of G10 currency pairs. For example, in January 2007 the Euro/Sterling exchange rate had peaked at over 1.52€/£. By the end of December 2008 the rate was 1.03€/£, a fall in value of nearly a third.
A big uptick in disputes relating to Euro-linked foreign exchange derivatives followed close behind. In the period between 2009 to 2013 a string of cases came before the English courts. Issues as diverse as jurisdiction clauses, private person status under FSMA, deceit, jurisdiction again, security for costs, breach of duty of care, close out strategies, and the jurisdiction of the FOS were litigated. But these cases were all linked by a common theme: FX customers trying by a range of creative strategies to claw back or avoid large losses suffered when they were caught on the wrong side of significant moves in exchange rates. And the cases that made the courts were only the tip of a much larger iceberg of disputes resolved in private settlements.
Now the pendulum is swinging the other way. The plight of Greece and the doubts about the future of the other “PIIGS” countries within the Euro if Greece exits has pushed Euro exchange rates back in the other direction. Rates have risen from 1.15€/£ in August 2013 to over 1.41€/£, and from 0.72€/$ as recently as May 2014 to 0.91€/$. These movements are evidently not (yet) as large as those seen in 2007/8. But they are easily large enough to move rates outside the relatively narrow rate ranges seen in most FX derivatives and to trigger increasingly substantial margin calls as mark to market values of trades on the wrong side of the affected currency pairs decline.
Will we see counterparties respond with complaints and legal proceedings once again? On the one hand fresh memories of the last crisis may have made participants in the FX derivatives markets more wary than before, and less prone to entering into the kind of long tail, narrow range structures that were so costly in the past. And financial institutions have undoubtedly learned many lessons from the claims and regulatory scrutiny they have faced since 2007. They would hope they are now better protected by improved internal procedures and safeguards from the allegations of mis-selling that characterised the last wave of cases.
On the other hand, the FCA Final Notices into FX benchmark manipulation have highlighted what the FCA called failure to “manage obvious risks around confidentiality, conflicts of interest and trading conduct”. If the LIBOR cases are any guide, claimants can be expected to make use of these findings to bolster their claims. Recent case law suggests they may well get some indulgence from the courts. So unless exchange rates recover unexpectedly, financial institutions’ legal teams would be prudent to anticipate increased activity in this area over the next couple of years, and take steps to prepare themselves.