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ALLEN & OVERY LEGAL RISKS OF DERIVATIVES WHAT’S HOT Carolyn Jackson PRMIA/ISDA 1Oth July, 2002 WHAT’S NOT.

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Presentation on theme: "ALLEN & OVERY LEGAL RISKS OF DERIVATIVES WHAT’S HOT Carolyn Jackson PRMIA/ISDA 1Oth July, 2002 WHAT’S NOT."— Presentation transcript:

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2 ALLEN & OVERY LEGAL RISKS OF DERIVATIVES WHAT’S HOT Carolyn Jackson PRMIA/ISDA 1Oth July, 2002 WHAT’S NOT

3 ALLEN & OVERY Outline  Legal Risk  The Costs  Legal Risk Model  Legal Risk Limit  Litigation Time Line

4 ALLEN & OVERY “Enforceabily presents the greatest risk participants face in derivatives transactions” Group of 30 July 1993 Appendix 1, p.43

5 ALLEN & OVERY WHAT is legal risk?

6 ALLEN & OVERY WHAT are the costs of legal risk?  ambiguity/lack of clarity  unenforceability of the contract  senior management time  front/back office time  legal fees  punitive/consequential damages  public exposure of internal policy  reputation

7 ALLEN & OVERY Current Anomalies Barings Liquidators vs. Deloitte & Touche tens of £ millions in legal fees vs the £13,000 fee for two audits

8 ALLEN & OVERY WHY are the legal risks of derivatives unique from traditional commercial/investment banking products?

9 ALLEN & OVERY Derivatives Involve  Mutual two-way exposure  Potentially unlimited exposure  Increased cross-border issues  Barely 20 year product  Uncertain regulatory/tax status  Out-of-court settlements  Evolving markets  Old law/new products

10 ALLEN & OVERY HOW are the claims brought?  Statute of Frauds  Lack of Capacity  Lack of Authority  Common Law Fraud  Breach of Fiduciary Duty  Negligent Misrepresentation  Regulatory Violation  Contract Based Claims  Procedural Violations

11 ALLEN & OVERY Modelling Legal Risk?  Qualitative vs. quantitative

12 ALLEN & OVERY The Efficient Portfolio of Legal Risks there is an optimum amount of legal risk for your firm risk management generally does not have as an objective the elimination of risk, but rather, the development of a framework for managing and understanding the risk

13 ALLEN & OVERY The Legal Bullet Return Risk x x Rf

14 ALLEN & OVERY The Model LR = f(D,R,L,J,C,P,I,Lo,T,E,S,Cr,St,Ch) where: D = documentation R = regulation L = your lawyers J = judicial decisions C = type of counterparties P = type of products I = initial mark-to-market Lo = location of counterparties T = technology E = exposure to counterparties S = your staff Cr = your credit St = your corporate structure Ch = choice of law/legal environment

15 ALLEN & OVERY WHICH variables are controllable?  Direct (D,L,C,P,I, Lo, T,E,S)  Indirect (Cr, Ch)  Uncontrollable? (R,J)

16 ALLEN & OVERY WARNING!!!!!! If your firm leads the industry in: types of counterparties, types of products, location, exposure

17 ALLEN & OVERY A legal risk limit?  If there are credit risk ratings, why not legal risk ratings  Why not weight each legal risk factor, as well as have a maximum limit for each factor?

18 ALLEN & OVERY The Volatility of Legal Risk  1980’s - low  1990s - high  2000-2010 - moderately high  beyond 2010 ?????

19 ALLEN & OVERY 1980’s - Derivatives Litigation Time Line  Interest /Currency Rate Transactions  Statute of Frauds  Tax Withholding  Regulatory Characterisation

20 ALLEN & OVERY 1990’s - Derivatives Litigation Time Line  Leveraged Products  Capacity/Authority  Suitability  Negligent Misrepresentation  Fraud  Regulatory Characterisations  Contract Based Claims

21 ALLEN & OVERY 2000’s - Derivatives Litigation Time Line  Credit Derivatives/Insurance  “Incorrect/Ambiguous” Documentation  Contract Based Claims

22 ALLEN & OVERY WARNING WHAT YOU ARE ABOUT TO SEE IS NOT A COMPLETE LIST

23 ALLEN & OVERY Derivatives Litigation Time Line 1991 Decision H of Lords Hammersmith & Fulham lack of power/authority 1994 Filed Lehman v Minmetals breach of contract counterclaim lack of capacity lack of authority securities fraud (d) breach of fiduciary duty negligencemisrepresentation mark up fraud (d) $53.5MM 1987 Decision Homestead vs. Life Savings anticipatory breach of contract good faith/fair dealing affirmative defense Statute of Frauds $6.2MM 1992 Decision Salomon Forex vs. Tauber breach of contract affirmative defense Statute of Frauds counterclaim illegal futures gambling laws bucket shop laws $26MM Drexel vs. Midland Contract Based, 353M

24 ALLEN & OVERY Derivatives Litigation Time Line 1995 BT vs. Dharmala lack of capacity suitability misrepresentation P& G vs. BT Ohio regulatory (SEC,CEA) laundry List SEITA vs. SBIL regulatory fraud fiduciary duty lack of capacity 1996 1998

25 ALLEN & OVERY Derivatives Litigation Time Line 2002 Filed Eternity vs. Morgan Guaranty breach of contract breach of good faith fraud negligent misrepresentation consequential damages $14MM,$6MM 2000 Filed Korea Life vs. Morgan Guarantyfraud negligent misrepresentation breach of contract violations of Korean law violations of NY gambling laws $90MM Peregrine vs. Robinson Contract Based $78MM ANZ vs. Soc Gen Contract Based, $8MM Griffin vs. Citibank, Tax 2001 Caiola vs. Citibank regulatory

26 ALLEN & OVERY Beyond 2010?

27 ALLEN & OVERY Conclusion  Legal Risk  Quantitative  Legal Risk Model  Towards a Legal Risk Limit

28 ALLEN & OVERY LEGAL RISKS OF DERIVATIVES WHAT’S HOT Carolyn Jackson PRMIA/ISDA 1Oth July, 2002 WHAT’S NOT


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