ALLEN & OVERY LEGAL RISKS OF DERIVATIVES WHAT’S HOT Carolyn Jackson PRMIA/ISDA 1Oth July, 2002...

ALLEN & ALLEN & OVERYOVERY

LEGAL RISKS OF DERIVATIVES

WHAT’S HOT

Carolyn Jackson

PRMIA/ISDA1Oth July, 2002

WHAT’S NOT


Outline

Legal Risk

The Costs

Legal Risk Model

Legal Risk Limit

Litigation Time Line


“Enforceabily presents the greatest risk participants face in derivatives transactions”

Group of 30July 1993Appendix 1, p.43


WHAT is legal risk?


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


Current Anomalies

Barings Liquidators vs. Deloitte & Touche

tens of £ millions in legal fees vs the £13,000 fee for two audits


WHY are the legal risks of derivatives unique from

traditional commercial/investment banking

products?


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


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


Modelling Legal Risk?

Qualitative vs. quantitative


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 objectivethe elimination of risk, but rather, the development ofa framework for managing and understanding the risk


The Legal Bullet

Return

Risk

xx

Rf


The ModelLR = f(D,R,L,J,C,P,I,Lo,T,E,S,Cr,St,Ch)where:D = documentationR = regulationL = your lawyersJ = judicial decisionsC = type of counterpartiesP = type of products I = initial mark-to-market Lo = location of counterpartiesT = technologyE = exposure to counterpartiesS = your staffCr = your creditSt = your corporate structureCh = choice of law/legal environment


WHICH variables are controllable?

Direct (D,L,C,P,I, Lo, T,E,S)

Indirect (Cr, Ch)

Uncontrollable? (R,J)


WARNING!!!!!!

If your firm leads the industry in:

types of counterparties,types of products,location,exposure


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?


The Volatility of Legal Risk

1980’s - low

1990s - high

2000-2010 - moderately high

beyond 2010 ?????


1980’s - Derivatives Litigation Time Line

Interest /Currency Rate Transactions

Statute of Frauds

Tax Withholding

Regulatory Characterisation



Leveraged Products Capacity/Authority Suitability Negligent Misrepresentation Fraud Regulatory Characterisations Contract Based Claims



Credit Derivatives/Insurance

“Incorrect/Ambiguous” Documentation

Contract Based Claims


WARNINGWHAT YOUARE ABOUTTO SEE IS NOTA COMPLETE LIST


Derivatives Litigation Time Line

1991

Decision H of LordsHammersmith & Fulhamlack of power/authoritylack of power/authority

1994

FiledLehman v Minmetalsbreach of contractbreach of contractcounterclaimlack of capacitylack of capacitylack of authoritylack of authoritysecurities fraud (d)securities fraud (d)breach of fiduciary dutybreach of fiduciary dutynegligencenegligencemisrepresentationmisrepresentationmark up fraud (d)mark up fraud (d)$53.5MM$53.5MM

1987

DecisionHomestead vs. Life Savingsanticipatory breach of contractanticipatory breach of contractgood faith/fair dealinggood faith/fair dealingaffirmative defenseStatute of FraudsStatute of Frauds$6.2MM$6.2MM

1992

DecisionSalomon Forex vs. Tauberbreach of contractbreach of contractaffirmative defenseStatute of FraudsStatute of Fraudscounterclaimcounterclaimillegal futuresillegal futuresgambling lawsgambling lawsbucket shop lawsbucket shop laws$26MM$26MMDrexel vs. MidlandContract Based, 353M



1995

BT vs. Dharmalalack of capacitysuitability misrepresentation

P& G vs. BTOhioregulatory (SEC,CEA)laundry List

SEITA vs. SBILregulatoryfraudfiduciary dutylack of capacity

1996 1998



2002

FiledEternity vs. Morgan Guarantybreach of contractbreach of contractbreach of good faithbreach of good faithfraudfraudnegligent misrepresentationnegligent misrepresentationconsequential damagesconsequential damages$14MM,$6MM$14MM,$6MM

2000

FiledKorea Life vs. Morgan Guarantyfraudfraudnegligent misrepresentationnegligent misrepresentationbreach of contractbreach of contractviolations of Korean lawviolations of Korean lawviolations of NY gambling lawsviolations of NY gambling laws$90MM$90MM

Peregrine vs. RobinsonContract Based$78MMANZ vs. Soc GenContract Based, $8MMGriffin vs. Citibank, Tax

2001

Caiola vs. Citibankregulatory


Beyond 2010?


Conclusion

Legal Risk

Quantitative

Legal Risk Model

Towards a Legal Risk Limit


LEGAL RISKS OF DERIVATIVES

WHAT’S HOT

Carolyn Jackson

PRMIA/ISDA1Oth July, 2002

WHAT’S NOT

ALLEN & OVERY LEGAL RISKS OF DERIVATIVES WHAT’S HOT Carolyn Jackson PRMIA/ISDA 1Oth July, 2002...

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