allen & overy legal risks of derivatives what’s hot carolyn jackson prmia/isda 1oth july, 2002...
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ALLEN & ALLEN & OVERYOVERY
LEGAL RISKS OF DERIVATIVES
WHAT’S HOT
Carolyn Jackson
PRMIA/ISDA1Oth July, 2002
WHAT’S NOT
ALLEN & ALLEN & OVERYOVERY
Outline
Legal Risk
The Costs
Legal Risk Model
Legal Risk Limit
Litigation Time Line
ALLEN & ALLEN & OVERYOVERY
“Enforceabily presents the greatest risk participants face in derivatives transactions”
Group of 30July 1993Appendix 1, p.43
ALLEN & ALLEN & OVERYOVERY
WHAT is legal risk?
ALLEN & ALLEN & OVERYOVERY
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
ALLEN & ALLEN & OVERYOVERY
Current Anomalies
Barings Liquidators vs. Deloitte & Touche
tens of £ millions in legal fees vs the £13,000 fee for two audits
ALLEN & ALLEN & OVERYOVERY
WHY are the legal risks of derivatives unique from
traditional commercial/investment banking
products?
ALLEN & ALLEN & OVERYOVERY
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
ALLEN & ALLEN & OVERYOVERY
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
ALLEN & ALLEN & OVERYOVERY
Modelling Legal Risk?
Qualitative vs. quantitative
ALLEN & ALLEN & OVERYOVERY
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
ALLEN & ALLEN & OVERYOVERY
The Legal Bullet
Return
Risk
xx
Rf
ALLEN & ALLEN & OVERYOVERY
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
ALLEN & ALLEN & OVERYOVERY
WHICH variables are controllable?
Direct (D,L,C,P,I, Lo, T,E,S)
Indirect (Cr, Ch)
Uncontrollable? (R,J)
ALLEN & ALLEN & OVERYOVERY
WARNING!!!!!!
If your firm leads the industry in:
types of counterparties,types of products,location,exposure
ALLEN & ALLEN & OVERYOVERY
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?
ALLEN & ALLEN & OVERYOVERY
The Volatility of Legal Risk
1980’s - low
1990s - high
2000-2010 - moderately high
beyond 2010 ?????
ALLEN & ALLEN & OVERYOVERY
1980’s - Derivatives Litigation Time Line
Interest /Currency Rate Transactions
Statute of Frauds
Tax Withholding
Regulatory Characterisation
ALLEN & ALLEN & OVERYOVERY
1990’s - Derivatives Litigation Time Line
Leveraged Products Capacity/Authority Suitability Negligent Misrepresentation Fraud Regulatory Characterisations Contract Based Claims
ALLEN & ALLEN & OVERYOVERY
2000’s - Derivatives Litigation Time Line
Credit Derivatives/Insurance
“Incorrect/Ambiguous” Documentation
Contract Based Claims
ALLEN & ALLEN & OVERYOVERY
WARNINGWHAT YOUARE ABOUTTO SEE IS NOTA COMPLETE LIST
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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
ALLEN & ALLEN & OVERYOVERY
Derivatives Litigation Time Line
1995
BT vs. Dharmalalack of capacitysuitability misrepresentation
P& G vs. BTOhioregulatory (SEC,CEA)laundry List
SEITA vs. SBILregulatoryfraudfiduciary dutylack of capacity
1996 1998
ALLEN & ALLEN & OVERYOVERY
Derivatives Litigation Time Line
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
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Beyond 2010?
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Conclusion
Legal Risk
Quantitative
Legal Risk Model
Towards a Legal Risk Limit
ALLEN & ALLEN & OVERYOVERY
LEGAL RISKS OF DERIVATIVES
WHAT’S HOT
Carolyn Jackson
PRMIA/ISDA1Oth July, 2002
WHAT’S NOT