TY - JOUR
AU - Malik, Sabur
AB - Key points The proliferation and complexity of derivatives continues to grow. New York and London have built up a body of precedent and judicial expertise. In London, the judicial response is centred around the specialist Financial List and the Test Case Scheme. These have helped ensure the judiciary keeps apace with market developments. However, judges from many jurisdictions grapple with understanding the complexities inherent in derivatives. There is a growing trend towards commercial arbitration of disputes but calibrated incorrectly, this could impede the development of precedent and more generally conflict with open justice principles. P.R.I.M.E. Finance offers judicial training, industry education, the establishment of a database of case law, the provision of expert opinion and arbitration. Arbitral bodies inherently are primed to privacy, and finality of judgments. In order to work in harmony with courts, we set out a template for deciding which cases should be litigated, and which arbitrated and explore the challenges. 1. Introduction Between 2015 and 2021 English Courts handed down 64 judgments in cases that made reference to the ‘ISDA master agreement’;1 of these 28 were litigated in the High Court’s Specialist Financial List being classified ‘Derivatives/complex financial products’.2 This article considers and contrasts judicial and industry initiatives in improving the efficiency and accuracy of judgments in complex financial derivatives disputes with a special focus on arbitration. In January this year the Supreme Court handed down a controversial judgment with profound ramifications for the trend towards commercial arbitration. In The FCA & Ors v Arch Insurance (UK) Ltd & Ors [2021]3 (‘Arch Insurance’) the Court ruled that insurance companies’ business interruption clauses covered COVID-19 in a move that will benefit thousands of Small and Medium Enterprises (SMEs) to the tune of an estimated £2 billion. In doing so the Court simultaneously overturned existing authority4 and pushed hard against the border of law with policy in a manner that would be plainly unavailable under arbitration. Put simply, had the matter been arbitrated rather than litigated, thousands of SMEs would now be bankrupt. While initial legal comment has focused on the narrow facts of the case few, if any, have considered its implications for commercial arbitration and more generally the role of equity in commercial transactions. Specifically for derivatives, long gone are the days where derivatives represented simple grain futures. The sophistication of modern derivatives requires specialist mathematicians (quants) for their valuation with carefully calibrated models. Valuations can turn on the calibration of a single variable thus leading to close-out valuation disputes. The market now talks of third and fourth generation derivatives of multi-layered wrappers for underlying financial derivatives such as CDO squared, index credit tranches, and volatility derivatives options. In turn these derivatives can be packaged together synthetically, or formally via true sale securitization. When combined with different usages, actors, novel structures, jurisdictions and regulatory approaches, adjudicating complex derivatives disputes has become difficult, time-consuming and expensive. One dispute can entail numerous mini-trials to settle conflict of laws, capacity to contract, mis-selling, differing construction, differing views on market practice, valuation and appropriate remedy. With the introduction of swathes of highly prescriptive EU-origin legislation, long gone are the days when English judges could seek refuge in familiarity with the trusty shield of the common law. In this article we consider to what extent industry-inspired attempts to promote private arbitration are in harmony with the UK’s judicial response to this phenomenon of increasing complexity in English law. We analyse the performance of the High Court’s Financial List and whether it has succeeded in ameliorating the quality of judgments. In the final part, we critically consider arbitration and its intersection with the law presenting our views on the optimal balance between arbitration and litigation. 2. The problem with the status quo: legal Star Wars It is true that EMIR5 has interdicted ab initio more rudimentary disputes via its mandatory trade confirmation requirement,6 early reporting of disputes to the competent authority,7 and periodic portfolio reconciliation regime8 but where irreconcilable disputes persist—typically where the performance of the derivative contract has left one party out of pocket—litigation will follow. At first instance, typically a solitary High Court judge will preside over the case and deliver a judgment. While the High Court is split into different divisions according to broad subject matter, judges nevertheless remain generalists by nature—they must be aware of all aspects of the law: ‘judges breathe the sea air when dealing with admiralty cases one day, to find the measure of market practices when considering commercial disputes the next.’9 This is not to disparage judges’ abilities, Lord Briggs (more from him shortly) now in the Supreme Court candidly confessed, ‘I am a jack of many legal trades, but master of none. And lest any of you should regard this confession of incompetence as an unreliably subjective view, just look at how comprehensively I was overruled last year by the Supreme Court in the latest round of the Lehman litigation: namely the Waterfalls case’.10 The large volume of complicated derivatives-centric litigation following the insolvency of Lehman Brothers in 2008 tested the judiciary’s ability to adjudicate complex financial products. Despite the principles of commercial contract construction purportedly being clear, Briggs J11 (as he then was) and Flaux J differed widely on approach in four cases12 that involved constructing the ISDA Master Agreement’s time limitation on the suspension of the condition precedent13 that requires no act of default occurring or persisting for the payment of monies owed. The wide-scale confusion not to mention industry alarm was eventually settled by the Court of Appeal in the epic Lomas & Ors v JFB Firth Rixson Inc & Ors14 where Longmore LJ, following the intervention of ISDA, confirmed the industry-preferred view that the condition precedent is not extinguished merely suspended (indefinitely if necessary)15 and this until the Event of Default or Potential Event of Default is cured or an Early Termination Date occurs.16 While the industry breathed a collective sigh of relief that the ‘troubling decision of Mr. Justice Flaux’17 had been corrected, the episode would have a profound effect on the financial market’s confidence in the judiciary’s ability to understand complex derivative contracts.18 Expert evidence can help but only to the extent that the judge can make sense of it, its context, relevance and weight.19 Opposing sides will often adduce differing expert evidence only adding to the complexity.20 Further, contracts can (perhaps inadvisably) make reference to generic ‘market practice’ leading to yet further competing expert evidence on what is considered normal market practice and to what extent this phrase can colour express terms in commercial contracts. The Supreme Court seemingly settled contract construction in Rainy Sky [2011],21 yet four years later Lord Neuberger set out a more literal approach in Arnold v Britton [2015]22 and while the Court has been keen to emphasize no conflict exists between the two judgments,23 it is difficult to ignore the difference in emphasis and bias.24 There is sufficient divergence in approach for conflicting sides to both seek support for their respective views by recourse to either Rainy Sky or Arnold. Indeed Hildyard J appears to have done just this in Lomas & Ors v Burlington Loan Management Ltd & Ors25 when discussing the principles governing ISDA master agreements construction. He made no reference to Arnold, preferring to cite Rainy Sky and in setting out his approach arguably commits the very error that Arnold cautioned against in giving undue prominence to flexibility and ‘general terms of reasonableness and good faith’.26 Throw into the mix a judge who has never heard of the risk metric ‘CS01’ less still understand its significance, and charting a safe course out of these choppy waters can prove overwhelming. 3. The Empire Strikes Back: judicial innovation Sensing the need for innovation, the judiciary’s response has been two-fold: (a) the introduction of a Financial List presided over by judges with specialist knowledge and experience; and (b) the amendment the Civil Procedure Rules (CPR) to introduce a new Financial Markets Test Case Scheme. This scheme allows for issues of general importance for which immediately relevant authoritative English law guidance is needed and no present cause of action between the parties is required, critically tacitly encouraging industry bodies to furnish submissions. The financial list Lord Thomas gave notice of the judiciary’s intention to create the Financial List in his Mansion House speech on 8 July 2015.27 His reasons included fostering ‘expertise of trial judges’. This aspiration was realized on 1 October that year when the High Court initiated a specialist ‘Financial List’, presided over by (initially) 12 judges from the Commercial and Chancery Courts. This List is governed by Part 63 A of the CPR and Practice Direction (PD) 63AA and is broadly any claim which: (a) principally relates to loans, project finance, banking transactions, derivatives and complex financial products, financial benchmark, capital or currency controls, bank guarantees, bonds, debt securities, private equity deals, hedge fund disputes, sovereign debt, or clearing and settlement and is for more than £50 million or equivalent; (b) requires particular expertise in the financial markets; or (c) raises issues of general importance to the financial markets. Financial markets include ‘the fixed income markets (covering repos, bonds, credit derivatives, debt securities and commercial paper generally), the equity markets, the derivatives markets, the loan markets, the foreign currency markets, and the commodities markets’. The judiciary considers that the Financial List lies at the ‘heart’ of London’s attractiveness as a judicial centre of expertise.28 Parties are allowed to request a judge with a ‘particular type of expertise or experience’ but may not ‘express a preference for a particular judge’.29 Further, ‘[t]he parties are also free to write to the Chancellor of the High Court and the Judge in Charge of the Commercial Court briefly identifying the key issues in the case and any matters considered relevant to a decision on which judge to allocate’.30 ‘As far as possible … [t]he same Judge will manage the case throughout and hear it.’31 Performance analysis Since inception the List has heard 118 cases,32 of these 28 were classified ‘Derivatives/complex financial products’.33 The first such case (which also happened to be the List’s first case) was filed in Oct 2015, The Royal Bank of Scotland Group PLC v I.V.P.C. Power 8 S.P.A. The latest such case is Cohen v Nationwide Building Society and others that was filed in November 2020.34 In 2015 the List included 4 derivatives/complex financial products cases; three in 2016; one in 2017; four in 2018; four in 2019; and 12 in 2020. Many cases have yet to reach their conclusion. Leeds City Council and others v Barclays Bank plc,35 for example, was filed in June 2018 but was recently updated on 13 January 2021. Five derivatives cases were discontinued; six closed following judgments; one was stayed following a Tomlin Order,36 and 16 remain open. From the decided cases, two were appealed, neither successfully. From this analysis it can be seen that the dataset is too small to reach firm conclusions and, in any case, great care would be needed before reaching conclusions on the extent to which (a) the lack of appeals; and (b) the lack of success in appeals are attributable to the Financial List? Furthermore, the extensive litigation of derivatives in the aftermath of the 2008 Lehman Brothers’ insolvency has created a repository of precedent for key common derivatives litigation touchpoints which has been bequeathed to the Financial List. The question may never be answerable to metronomic precision but the results so far are encouraging. The establishment of an in-house school of excellence in financial markets can only help. A related development is the induction of the financial market test case scheme. Financial markets test case scheme In an exciting development, following a test pilot scheme that ran from October 2015 to end September 2020, a new rule 6 exists in Practice Direction (PD) 63AA37 which allows for parties to seek judicial pronouncements on [1] a Financial List claim … which raises [2] issues of general importance in relation to which [3] immediately relevant authoritative English law [4] guidance is needed (‘a qualifying claim’), critically: without a present cause of action.38 The Supreme Court explains that the test scheme ‘enables a claim raising issues of general importance to financial markets to be determined in a test case without the need for a specific dispute between the parties where immediately relevant and authoritative English law guidance is needed’.39 The touchstone is to create precedent.40 There are thus two gateways to commencing such a claim. First it must qualify as a Financial List claim; secondly it must fulfil points [2]–[4], above, while acknowledging overlap between the two gateways. The intention is that both parties will mutually agree on such proceedings, having first agreed on the facts. At the first case management hearing the judge will determine whether the case is eligible under the Test Case Scheme according to: (a) whether the case is a qualifying claim, (b) it is a claim which can be satisfactorily determined as a test case, and (c) the arguments of all those with opposing interests in relation to the issues in question will be properly put before the court by those represented. ‘[T]he general rule will be that there shall be no order as to costs.’ To date only one case has been heard. In hearing the leapfrogged appeal, the Supreme Court showered the Test Case Scheme with praise: ‘It is a testament to the success of the Test Case Scheme procedure that it will have enabled the important legal issues raised in this case to be finally decided following a trial and an appeal to the Supreme Court in just over seven months.’41 There is much to celebrate about the speed in which decisive precedent has been issued on matters that have yet to be litigated. Equally the pace raises questions about whether the establishment of unappealable binding precedent in seven months is healthy, and whether cases would benefit from a slower approach allowing legal argument to develop organically and be subjected to more robust scrutiny in the Court of Appeal before progressing to the apex Court. Trade bodies co-opted We previously alluded to ISDA members’ concern about the ability of the judiciary to fully understand OTC derivatives following the widely divergent approaches of Flaux J and Briggs J in separate cases dealing with similar issues. In the co-joined appeals heard by the Court of Appeal in Lomas & Ors v JFB Firth Rixson Inc & Ors [2012], ISDA was granted permission to intervene. The resolution ‘delighted’42 ISDA and the broader market43 in a judgment that largely followed ISDA’s analysis. To what extent their Lordships were influenced by ISDA’s submission is not known, but the fact that the final judgment ‘essentially confirmed ISDA’s position on all significant issues’44 suggests that ISDA’s submission carried considerable persuasive effect. In a master stroke, the judiciary has co-opted industry bodies, per PD 63AA Rule 6.5: trade, professional or regulatory bodies ‘with the permission of the court, [may] be joined as a party or otherwise allowed to be represented’. This incorporation of consensus industry opinion into judicial hearings ensures that key test cases enjoy the benefit of expert industry consensus opinion rather than that latter observing as anxious spectators with no ability to influence proceedings or comment on documentation that they themselves may have drafted. Comparison with declaratory relief One issue remains. The Test Case Scheme should not be confused with declaratory relief already allowed for in Rule 40.20 of the CPR. Declaratory relief allows for the court to ‘make binding declarations whether or not any other remedy is claimed’. It is clear that the broadly worded Rule 40.20 affords courts a large degree of discretion. What then was the need for the introduction of the Financial Markets Test Case scheme? The courts’ approach to the different aspects of declaratory relief was explored in Pfizer Ltd v F. Hoffmann-La Roche AG & Anor [2019].45 It seems to us that the principal difference is that the Test Case scheme is primed to accommodate theoretical points of law, for which the broader market seeks urgent clarity, regardless of whether any case for action exists. In this sense it can deal with the theoretical in contrast to Courts’ approach to declaratory relief: ‘There must, in general, be a real and present dispute between the parties before the court as to the existence or extent of a legal right between them. However, the claimant does not need to have a present cause of action against the defendant.’46 4. Arbitration: The Return of the JEDI In parallel to this judicial innovation there has been a growing trend towards private arbitration for complex financial disputes. The London Court of International Arbitration (LCIA) reported ‘an all-time high of 444 referrals to the LCIA in 2020, with 407 arbitration cases fully administered by the LCIA pursuant to the LCIA Rules’47 amounting to a 10 per cent year on year increase. Due to the private nature of arbitration, it is not known how many concern derivatives.48 Motivations range from industry dissatisfaction with first instance judicial judgments on derivatives in jurisdictions that lack expertise, to privacy, to the wide enforceability of arbitral awards courtesy of 16649 states being signatories to the United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards.50 The UK has a long and strong tradition of encouraging arbitration which was bolstered yet further by their Lordships’ judgment in Premium Nafta Products Ltd v Fili Shipping Co Ltd [2007]51 where a long list of authorities favouring a narrow construction of arbitration clauses was brusquely dismissed in favour of a wide construction establishing a presumption in favour of arbitration when construing arbitration clauses. As arbitration is in the ascendency, it is critical to understand its implications on complex financial derivatives disputes. P.R.I.M.E. Finance A more recent arbitral body that attracted substantial industry interest is P.R.I.M.E. Finance, founded in January 201252 by former Allen & Overy senior Partner Professor Jeffrey Golden. The question we confront is: to what extent do these arbitral bodies, P.R.I.M.E. in particular, complement or conflict with judicial development, and what is the optimal balance between arbitration and litigation? Writing in 201053 (before the introduction of the Financial List)54 and reiterated in interviews,55 Golden’s central pitch was that complex financial disputes were not being adequately understood by generalist judges and that in a twist of irony, judges had ‘become’ sources of systemic risk due to their limited understanding of derivatives (a then $639 trillion market) and therefore delivering unpredictable judgments.56 Golden, a veteran of derivatives law, would have witnessed, in the 1990s, local authorities mis-selling of derivatives cases57 where in an instant UK courts declared tens of billions of dollars of derivatives contracts void ab initio, moneys returned with only simple interest. In comments to the author, this alarm was echoed by David Mangle—a former head of Research of ISDA—and Peter Hancock—the former JP Morgan Chief Risk Officer—under whose auspices credit derivatives developed and were popularized. Unrelated to the local authorities cases, speaking more generally Golden summarized: ‘“Whoosh”—that mistake goes across the globe, affecting trillions of dollars of trades.’58 P.R.I.M.E’s core activities are: dispute resolution/arbitration of complex financial disputes; judicial training and education; and ‘maintaining a central database of international precedents and source materials’.59 Golden initially talked of establishing an international financial court although in comments to the author, Golden highlighted P.R.I.M.E.’s work in supporting court determinations of financial markets by way of judicial education, conferences and providing expert opinion which ‘to date [is] arguably the larger part of [P.R.I.M.E.’s] activities’.60 There was much enthusiasm initially since (or perhaps due to) the growth in complex financial disputes flowing from the global financial crisis and Lehman Brothers’ insolvency particularly, yet a decade later and P.R.I.M.E. has yet to hear its first arbitration under its own rules.61 James Freeman, a Partner at Allen & Overy suggests that ‘the “generalist” arbitration institutions have proven increasingly capable of making suitable arbitral appointments for cases involving complex financial transactions’.62 When coupled with the LCIA’s record 2020 case load, Freeman is likely correct.63 Freeman offers another albeit subjective reason for P.R.I.M.E.’s lack of arbitrations: ‘counterparties perceive P.R.I.M.E. Finance to be an institution developed by banks’.64 This perception may be difficult to substantiate, and will certainly be denied by P.R.I.M.E., but the fact that senior ISDA members65 hold senior positions in P.R.I.M.E. may go some way towards encouraging this perception. Where P.R.I.M.E. has enjoyed more success is in assembling an impressive roster of over 200 legal and financial experts including former Supreme Courts justices and experts from across the financial industry. P.R.I.M.E. is primed to become the premiere repository of expert opinion and has already provided expert opinion in a number of cases.66 The problems confronting financial arbitration The broad issues confronting financial arbitration are known;67 we propose to bring colour to the discussion by addressing them within our analysis of contemporary court judgments. Opacity and lack of appeal In the UK ‘both the arbitration and the arbitral award are not generally a matter of public record’.68 Arbitration’s opacity and lack of public scrutiny has long left it exposed to accusations of providing fertile breeding ground for bad practice or, at its worst, deliberate bias. Whereas in open justice an impartial judge’s behaviour or circumspect interpretation of the law can be challenged via an appeal, in arbitration the lack of public hearing, more limited documentation of proceedings, and arbitral rules on finality make such challenges difficult. On finality, P.R.I.M.E., in common with most arbitral bodies, states: All awards shall be final and binding on the parties. The parties shall carry out all awards without delay and shall be deemed to have waived their right to any form of recourse insofar as such waiver can validly be made.69 The Arbitration Act 1996 ‘contains at least two provisions permitting courts to address arbitrators’ excess of authority, often articulated with reference to the French term excès de pouvoir or other related notions such as “jurisdiction” or “competence”.’70 In practical terms the high threshold of ‘serious irregularity’71 precludes most arbitral awards from judicial challenge. By contrast in June 2020 the Supreme Court handed down a damning judgment in Serafin v Malkiewicz & Ors72 declaring the Court had ‘no doubt’ that the trial judge had been ‘unfair’.73 The Court held further that the trial judge ‘evinced prejudice’ and cited the Court of Appeal’s description that his behaviour was ‘threatening and bullying’.74 Similar criticism is periodically directed against first instance Family Courts whose procedural rules preclude public access and scrutiny of judgments, yet their decisions are appealable. In JH v MF75 Russell J ordered a retrial as the trial judge’s—a QC no less—‘judgment was so flawed as to require a retrial’.76 As shocking as his offensive views77 may seem, the QC was ‘a senior judge, a Designated Family Judge, a leadership judge in the Family Court’.78 Thus while P.R.I.M.E.’s pedigree of experts is truly impressive, the aforementioned two cases vividly demonstrate that pedigree does not automatically translate into fair, impartial judgments. Regarding impartiality of arbitrators, the Supreme Court recently explored the issue in Halliburton Company v Chubb [2020].79 On the facts, the arbitrator to the dispute, Halliburton later came to know, was also arbitrating another dispute that covered related subject matter with Chubb. The arbitrator had failed to notify Halliburton and upon being confronted that ‘circumstances exist that give rise to justifiable doubts as to his impartiality’,80 offered to tender his resignation, which Chubb refused. The Supreme Court held that there was no case for apparent bias, in doing so clarified that the s.24 test for impartiality81 is a common law test of bias which will necessarily be fact-specific. There is a trend towards transparency, but moves fall well short of open justice principles of public hearings and public judgments enjoyed in litigation. The LCIA does not publish the name of parties, nor the decisions it reaches, per Article 30.3 of the LCIA arbitration rules 2020.82 The most it publishes is a ‘Challenge Decision Database’83 with brief, anonymized excerpts of the relevant decision. Further, Article 30 requires the parties themselves ‘to keep confidential all awards in the arbitration, together with all materials in the arbitration created for the purpose of the arbitration’.84 P.R.I.M.E. Finance Rules allow parties to agree to publish awards, although having yet to arbitrate its first case it remains to be seen how many parties will opt for publication. Decades of practice suggest few, if any, will. Indeed, P.R.I.M.E. cites ‘Confidentiality’ under its list of advantages.85 Inhibiting precedent Open justice leads to the development of jurisprudence. Judgments are scrutinized by lawyers and academics; novel ideas are explored that subsequently feed into counsels’ submissions. By this process the law develops. With the benefit of hindsight and multiple rounds of scrutiny and half-an-eye on equity, Senior Courts develop the common law. Where necessary, parliament legislates. Clearly private arbitration is the antithesis of this process, therefore a balance must be struck between open justice litigation and arbitration. No clearer example of this can found than the recent Arch Insurance86 case in which the Supreme Court justices overturned previous precedent in Orient Express87—ironically a case which two of their Lordships were previously engaged with. Law firms and insurers’ initial reaction to the judgment is one of incredulity. A critique of this case is beyond the scope of this article—it will certainly attract considerable academic comment in due course. We restrict our observation to their Lordships’ absence of meaningful explanation in overturning precedent, restricted to two short paragraphs.88 It is difficult not to conclude that public policy and equity weighed heavily on their Lordships’ minds while overturning precedent and delivering a judgment that would oblige insurance companies to pay out an estimated £2 billion to struggling SMEs. The key point is that had the matter been arbitrated, these SMEs would have lost and faced bankruptcy. Had Flaux J arbitrated Pioneer v Cosco89 and Britannia v Pioneer,90 they would have been decided incorrectly (as we now know) but more damagingly, the Courts would have been deprived of the opportunity to correct the error and set precedent. In an ironic twist, Golden’s criticism of inexperienced judges representing systemic risk might be levelled against arbitrations dealing with systemically important subject matters. Errors cannot be corrected and no precedent is created upon which the wider market can rely. Legal uncertainty—the antithesis to efficient, stable markets—pervades. Lord Briggs confronted this problem directly and forcefully while addressing P.R.I.M.E.: But I must end with a word of warning. If one effect of the present uncertainties is that there is a large shift in the current balance between Courts on one hand and Arbitration and ADR on the other, in favour of the latter, for the resolution of cross-border commercial and financial disputes, then transparency and open justice will be the inevitable victim, because privacy lies at the heart of both arbitration and ADR, (and mediation in particular), while arbitration thrives upon restricting avenues of appeal. The just determination of disputes by independent judges in public courtrooms, and the publication of the reasons for their judgments, is a corner stone of the rule of law, as much in the commercial and financial spheres as it is in crime and public law. However complex the law has become, there can be no rule of law unless its development takes place in public, for all to be able to see and learn what the law is, and for academics to be able to apply and proclaim their invaluable criticism of judicial thought processes.91 Golden highlights that there are circumstances where speed, expertise and finality may trump transparency and open justice principles, citing the example of CDS Credit Derivatives Determination Committees.92 This is undoubtedly true but not necessarily for these reasons.93 The ultimate reason why credit event determination committees are suitable for arbitration is because they do not typically turn on contentious points of law, but are principally fact-finding committees. This makes them primed for arbitration, as we shall sate shortly in point B of section ‘Cases suitable for arbitration’. The role of equity Missing from the debate is a discussion on equity and its relative use in litigation and arbitration. The role of equitable principles is commercial transactions is among the most contentious issues in English law due to its conflict with commercial contract law’s requirement for legal certainty predicated on the express wording of the agreement, albeit set within the overall context of the contract. Where the express wording is clear, intention, hindsight or the unfairness of the bargain is not considered. Further, equity’s ‘broad over-arching’ principles ‘expressed at such a high level of generality’ does little to provide practical guidance when adjudicating complex financial disputes.94 Notwithstanding this, the role of equity in business has ‘increased rather than receded’.95 In 1998 (then) Millett LJ confronted this controversy head on in his seminal paper, ‘Equity’s Place in the Law of Commerce’.96 Millett LJ acknowledges that equitable principles should not be confined to family and friendship and should be extended to the commercial field, but not in an uncontrolled manner. We do not seek to settle such a hotly contested area of law (even if that were possible) but only wish to note that equitable considerations do play on judges’ minds when considering an approach, nowhere more clearly demonstrated than in Arch Insurance, discussed above. Perhaps this is what Lord Sales had in mind when he posited, ‘Equity has one trajectory and contract has its distinct trajectory’.97 Lawyers coming from equity and those from Contract tend to differ in approach: ‘chancery lawyers and common lawyers have a tendency to think about issues in somewhat different ways’.98 Lord Briggs states, ‘some commercial lawyers, including commercial judges [believe] that equity has arrogated to itself far too great a role in the commercial field’.99 He continues to summarize Gloster LJ’s dissenting judgment ‘where she observed that by the invocation of equitable principles the majority (including me) were impracticably and unrealistically introducing into commercial transactions the moral standards of the vicarage’.100 Arbitrators of complex financial transactions stick more rigidly to the facts of the particular case in front of them, as presented by the two parties. They lack jurisdiction to develop the law and are not typically focused on wider societal implications. They seek to make findings of facts and apply the law, typically contract law, to the case. Returning to Arch Insurance one final time, even if arbitrators were not bound by Orient Express, we do not believe that arbitrators would have found in favour of the SMEs, side-stepping equitable principles and applying contract law to the letter of the law. Certainly, large financial instructions would prefer the latter, yet smaller institutions and buy-side investors would likely welcome the softer hands of equity. 5. Arbitration and litigation: the optimal balance What then is the optimal balance between arbitration and litigation? We now present our conclusions which we commend to arbitral bodies for incorporation into their rules. Cases that should be litigated Cases that involve novel points of law should not be arbitrated but litigated in order to allow the law to develop by establishing binding precedent. Parties to a case seek resolution of their dispute, not altruistic funding of the development of law. Hence, arbitral bodies must update their rules to discourage the practice and introduce clauses that allow them to refuse arbitrations where they consider the issues raise industry-wide matters of interest for which public, binding precedent needs to be established. Cases where a party believes existing good law was wrongly decided and seeks to overturn existing precedent by appealing to a higher court should be litigated in order to allow the law to develop where necessary. Per, above, arbitral bodies should refuse to progress such arbitrations where it becomes apparent at the first case management meeting that there exists a realistic prospect of success for the existing precedent to be overturned. Example: Cases involving the subject matter in first instance Pioneer v Cosco101 and Britannia v Pioneer102 (before they were overturned). Cases akin to class action (ie cases arguing a point that will affect a large number of persons) should be litigated as courts will take a more holistic view of the implications of a case rather than the narrow facts of the disputing parties—Example: The FCA & Ors v Arch Insurance (UK) Ltd & Ors [2021]. Cases suitable for arbitration D. Cases where litigation would otherwise occur in jurisdictions vitiated with inexperience, corruption or poor adherence to the rule of law and where the parties are subject to the jurisdiction of a party to the 1958 United Nations Convention on the Recognition and Enforcement of Foreign Arbitral Awards to allow enforcement of awards. E. International disputes where the law is uncontested but the facts are disputed, arbitration with local arbitrators will likely be the most efficient route. F. Remaining disputes in mature, well-functioning jurisdictions, where the dispute turns on differing facts or minor interpretations of the law. Point A will remain the most contentious recommendation as it would involve an arbitral body actively declining business. Our view on this matter is the same as Lord Briggs (See fn 91). Given that P.R.I.M.E.’s experts include a large number of former senior judges, including Supreme Court justices; Lord Thomas—who founded the Financial Listand Sir William Blair (a former Chair of the Financial List), it is possible that these experts would feel conflicted in a scenario where the arbitral body accepted for arbitration a case that had it been litigated would likely have led to a clarification or development of the law.103 6. Conclusion Much like marriage, arbitration and litigation need not be in conflict, but only if the relationship is calibrated correctly with each respecting the other’s domain. Backed up by ISDA’s 2018 publication of model arbitration clauses which includes P.R.I.M.E., the push towards commercial arbitration is set to continue. If commercial arbitration of derivatives is to have a viable future then we consider our aforementioned template to be the bedrock for the correct approach. We have repeatedly stated that it is our belief that the Supreme Court applied equitable principles in Arch Insurance but declined to evince them in their judgment. The role of equity and its interaction with commercial contracts remains ambiguous and we salute Lord Briggs’ candour and courage in addressing this problem: ‘There is therefore a need to formulate with considerable clarity and specificity the principles which, cumulatively, justify equity’s intervention in a particular type of commercial context ….’104 Clarification of the same will likely take years, if not decades, but the move is essential. Footnotes 1 Database search for ‘ISDA master agreement’. 2 HMCTS, ‘Data Extract from HM Courts & Tribunals E-Filing Service’ <https://efile.cefile-app.com> accessed 14 February 2021. For the non-Financial List cases, a definitive figure remains elusive. Derivatives feature commonly in packages of financial transactions but at what point a case becomes significantly dedicated to derivatives will remain a subjective call. 3 [2021] UKSC 1. 4 [2021] UKSC 1 at [312]. 5 Regulation (EU) No 648/2012 of the European Parliament and of the Council of 4 July 2012 on OTC derivatives, central counterparties—onshored to the UK statute book as retained legislation. Commonly known as European Market Infrastructure Regulation—EMIR. 6 Commission Delegated Regulation (EU) 149/2013, art 12. 7 Commission Delegated Regulation (EU) 149/2013, art 15. 8 Commission Delegated Regulation (EU) 149/2013, art 13. 9 Lord Thomas, ‘Dinner for Her Majesty’s Judges’ (Mansion House, London, 8 July 2015). 10 Lord Briggs, ‘Dispute Resolution in Uncertain Times’ (2018) para 1 <https://www.supremecourt.uk/docs/speech-180122.pdf>. 11 Lord Briggs now sits in the Supreme Court. On 22 January 2018 he delivered a speech at P.R.I.M.E. Finance’s annual conference. 12 Two decided at first instance by Flaux J: [2011] EWHC 692 (Comm) and [2011] EWHC 1692 (Comm); two by Briggs J: [2011] EWHC 718 (Ch) and [2010] EWHC 3372 (Ch). 13 Section 2(a)(iii) of the 1992/2002 ISDA Master agreement states, inter alia, that the payment or delivery obligation has a ‘condition precedent no Event of Default or Potential Event of Default with respect to the other party has occurred and is continuing …’. The problem occurs if, after close-out netting, the non-defaulting party owes the defaulting party money—yet the above condition precedent precludes payment. When, then, if at all, does the condition precedent expire? 14 [2012] EWCA Civ 419. 15 ‘We would therefore decide that the payment obligation of the Non-defaulting Parties is suspended (rather than extinguished) during the currency of an Event of Default under the Master Agreement and will revive if the Event of Default is cured at any time before the outstanding Transactions are terminated.’; [2012] EWCA Civ 419 at [35]. 16 [2012] EWCA Civ 419 at [62]. 17 ‘ISDA Welcomes the English Court of Appeal’s Decision to Uphold ISDA Master Agreement in LBIE JudgmentInternational Swaps and Derivatives Association’ <https://www.isda.org/2012/04/03/isda-welcomes-the-english-court-of-appeals-decision-to-uphold-isda-master-agreement-in-lbie-judgment/> accessed 26 January 2021. 18 Jonathan Ross, ‘The Case for P.R.I.M.E. Finance: P.R.I.M.E. Finance Cases’ (2012) 7 Capital Markets Law J 221. In this, the author dedicates considerable attention to the deficiency of these cases in his justification for the establishment of the new arbitral body. 19 A note on expert evidence is in order. Civil Procedure Rule 35.1 restricts general use of expert evidence—explored at length in [2016] EWHC 2494 (Ch). Nevertheless, expert evidence has featured in derivatives cases, and not just to determine the meaning of market practice. In Crestsign v Natwest [2014] EWHC 3043 (Ch) the judge allowed evidence from ‘Mrs Jackie Bowie, an expert adviser on the hedging of interest rate risks and on the suitability of financial products called [Interest Rate] derivatives …’. More recently in Dudding v RBS [2017] EWHC 2207 (Ch), Asplin J (DBE) rejected RBS’ opposition to expert evidence and held that it was ‘reasonably required’ for a range of questions concerning derivatives mis-selling. 20 Judges must provide reasons for selecting a preponderant expert view; a failure of which might be considered a valid ground for appeal—see Flannery and another v Halifax Estate Agencies Ltd [2000] 1 WLR 377 where the Court of Appeal accepted that the conclusion reached by the trial judge was open to him, but that he had failed to evince reasons for preferring one expert over another and so ordered a new trial. 21 [2011] UKSC 50. 22 [2015] UKSC 36 at [17]—[23] 23 See Wood v Capita [2017] UKSC 24, restated recently in [2021] UKSC 1 at [62]–[66]. 24 R Craig Connal QC, ‘Has the Rainy Sky Dried Up? Arnold v Britton and Commercial Interpretation’ (2015) 20 Edinburgh Law Rev 71. 25 [2016] EWHC 2417 (Ch). 26 [2016] EWHC 2417 (Ch) at [48]. 27 [2016] EWHC 207 (Ch) at [3] 28 Lord Briggs (n 11) para 25. 29 Courts and Tribunals Judiciary, ‘Financial List: FAQ’ para 11 <https://www.judiciary.uk/publications/financial-list-faq/> accessed 1 February 2021. 30 Ibid. 31 Ibid 13. 32 HMCTS (n 2). 33 Ibid. 34 Case number FL-2020-000050. 35 Case number FL-2018-000009. 36 A Tomlin order is a form of consent order when both parties mutually agree to stay proceedings according to the terms of a schedule. 37 MOJ, ‘PRACTICE DIRECTION 63AA – FINANCIAL LIST’ <https://www.justice.gov.uk/courts/procedure-rules/civil/rules/financial-list/practice-direction-63aa-financial-list> accessed 2 January 2021. 38 PD 63AA, rule 6. Also summarized in [2021] UKSC 1 at [2]. 39 [2016] EWHC 207 (Ch) at [3]. 40 Lord Thomas (n 9) 3. 41 [2021] UKSC 1 at [43]. 42 ‘ISDA Welcomes the English Court of Appeal’s Decision to Uphold ISDA Master Agreement in LBIE JudgmentInternational Swaps and Derivatives Association’ (n 13). 43 Marc Florent, a partner at Allen & Overy said the ruling ‘represents a welcome confirmation of the orthodox industry understanding …’ per: Jane Croft, ‘Court Backs Buyers of Lehman Rate Swaps’ The Financial Times (London, 3 April 2012) <https://www.ft.com/content/d4597ba4-7d92-11e1-81a5-00144feab49a> accessed 2 April 2021. 44 ‘ISDA Welcomes the English Court of Appeal’s Decision to Uphold ISDA Master Agreement in LBIE JudgmentInternational Swaps and Derivatives Association’ (n 13). 45 [2019] EWHC 1520 (Pat) at [69]–[85]; also [2006] EWCA Civ 1618 at [15]. 46 [2009] EWCA Civ 387 at [120]. 47 ‘Record Number of LCIA Cases in 2020’ <https://www.lcia.org/News/record-number-of-lcia-cases-in-2020.aspx> accessed 24 January 2021. 48 The author’s request to the LCIA for information went unanswered. The 2020 breakdown of headline figures is due but not yet available as of writing (April 2021) but the 2019 breakdown shows a ‘continued and significant growth in the number of LCIA arbitrations in the banking and finance sector …’; Annual Casework Report 2019—The LCIA Records its Highest Number of Cases <https://www.lcia.org/News/annual-casework-report-2019-the-lcia-records-its-highest-numbe.aspx> accessed 15 April 2021. 49 ‘Status: Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York, 1958) (the ‘New York Convention’) | United Nations Commission On International Trade Law’ <https://uncitral.un.org/en/texts/arbitration/conventions/foreign_arbitral_awards/status2> accessed 4 February 2021. 50 UN, ‘Convention on the Recognition and Enforcement of Foreign Arbitral Awards (New York, 1958) (the ‘New York Convention’) | United Nations Commission On International Trade Law’ <https://uncitral.un.org/en/texts/arbitration/conventions/foreign_arbitral_awards> accessed 4 February 2021. 51 [2007] UKHL 40 at [11]–[15]. 52 Website: https://primefinancedisputes.org/ 53 Jeffrey Golden, ‘World Financial Markets Need a World Financial Court’ (The Guardian, 3 November 2010) <http://www.theguardian.com/law/2010/nov/03/world-financial-markets-court> accessed 26 January 2021. 54 While reviewing a draft of this article, Professor Golden noted to the author that he is a huge supporter of the Financial List and considers it something of a model. 55 Jeffrey Golden, ‘Jeffrey Golden Talks to Law Vox about International Financial Disputes’ <https://soundcloud.com/oupacademic/jeffrey-golden-talks-to-law-vox-international-financial-disputes> accessed 26 January 2021. 56 Jeffrey Golden, ‘Judges and Systematic Risk in the Financial Markets’ (2012) 18 Fordham J Corporate & Financial Law s II. Why Courts are Important. 57 Hazell v Hammersmith and Fulham LBC [1992] 2 AC 1; and Westdeutsche Landesbank Girozentrale v Islington LBC [1996] UKHL 12 which set out the remedy for contracts that were later voided ab initio. Westdeutsche remains to this date a leading authority in trust law. 58 Golden, ‘Judges and Systematic Risk in the Financial Markets’ (n 53) s C. Standardization. 59 ‘P.R.I.M.E. Finance What We Do’ <https://primefinancedisputes.org/page/what-we-do> accessed 26 January 2021. 60 Professor Golden’s feedback to author; 17 February 2021. 61 Although Professor Golden advised the author that a number of its experts have acted as arbitrators under other arbitral bodies’ rules. 62 James Freedman and Tomasz Hara, ‘Arbitration of Banking and Financial Disputes’s Institutional or ad hoc arbitration?'. 63 Although the headline figure does not reveal how many related to derivatives disputes. 64 Freedman and Hara (n 62) s P.R.I.M.E. Finance. 65 P.R.I.M.E.’s current chair is a former ISDA CEO Robert (‘Bob’) Pickle. Professor Golden, the founder and Chair Emeritus, was instrumental in drafting the ISDA master agreements. 66 For example, Lehman Bros Intl(Europe) vAG Fin. Prods, Inc, 2018 N.Y. Misc. LEXIS 2974, 2018 NY Slip Op 51100(U). 67 See for example: Bahar Alamdari, ‘The Emerging Popularity of International Arbitration in the Banking and Financial SectorIs This a Fashionable Trend or a Viable Replacement?' (PhD Thesis) (Institute of Advanced Legal Studies, University of London 2016) s 5.4.3. 68 Halliburton Company v Chubb [2020] UKSC 48 at [6]. 69 P.R.I.M.E., ‘Review of P.R.I.M.E. Finance Arbitration Rules’ <https://primefinancedisputes.org/page/review-of-p-r-i-m-e-finance-arbitration-rules-1> accessed 24 January 2021. Rule 39.2 of the latest draft new rules. 70 William W Park, ‘Tax and Arbitration’ (2020) 36 Arbitration International 157, s The English Court Action. 71 The Arbitration Act 1996, s 68. Narrow grounds are also included in s 69. 72 Serafin v Malkiewicz & Ors [2020] UKSC 23. 73 Serafin v Malkiewicz & Ors [2020] UKSC 23 at [39]. 74 Serafin v Malkiewicz & Ors [2020] UKSC 23 at [32]. 75 [2020] EWHC 86 (Fam). 76 [2020] EWHC 86 (Fam) at [58]. 77 Readers may be curious that he had held, ‘it is not only permissible but also acceptable for penetration to continue after the complainant has said no … a complainant must and should physically resist penetration, in order to establish a lack of consent’. 78 [2020] EWHC 86 (Fam) at [37]. 79 Halliburton Company v Chubb [2020] UKSC 48. 80 Arbitration Act 1996, s 24. 81 s 24 of the Arbitration Act 1996 governs the power of the court to remove an arbitrator. The s 24(1)(a) ground is for ‘impartiality’ but the test for impartiality is left undefined. In Halliburton v Chubb their Lordships explained the test in paras 56–59. 82 ‘LCIA Arbitration Rules’ <https://www.lcia.org/Dispute_Resolution_Services/lcia-arbitration-rules-2020.aspx#Article%2030> accessed 24 January 2021. 83 ‘Challenge Decision Database’ <https://www.lcia.org/challenge-decision-database.aspx> accessed 24 January 2021. 84 ‘LCIA Arbitration Rules’ (n 80). 85 ‘P.R.I.M.E. Finance’s The advantages of P.R.I.M.E. Finance arbitration': <https://primefinancedisputes.org/page/arbitration> accessed 1 February 2021. Rule 39.9 of the 19 January 2021 draft new rules states: ‘An award may be made public with the consent of all parties ….’ 86 [2021] UKSC 1. 87 [2010] EWHC 1186 (Comm). 88 [2021] UKSC 1 at [309]–[310]. 89 [2011] EWHC 1692 (Comm). 90 [2011] EWHC 692 (Comm). 91 Lord Briggs (n 11) para 31. 92 Feedback to author; 17 February 2021. 93 Speed and finality are laudable and swift determination of Credit Events is required but this cannot trump accuracy and impartiality. Lingering concerns on impartiality persist evidenced by IOSCO, ‘Statement on the ISDA Credit Derivatives Determinations Committees and CDS Auction Processes’ (10 October 2017) <https://www.iosco.org/library/pubdocs/pdf/IOSCOPD581.pdf>. Determination Committee (DC) participants may hold positions in the CDSs and bonds and the lingering suspicion of economic self-interest persists. A court may disagree with a DC’s findings. On 21 December 2017 a 15-member Americas DC unanimously voted that no Credit Event occurred with respect to Windstream Services LLC (https://www.cdsdeterminationscommittees.org/documents/2017/12/windstream-vote-dec-21.pdf). Multiple other requests found likewise, only for a New York court to find otherwise on 15 February 2019 (https://www.cdsdeterminationscommittees.org/documents/2019/02/1862178.pdf). 94 Lord Briggs, ‘EQUITY IN BUSINESS’ (THE DENNING SOCIETY LECTURE 2018, Lincoln’s Inn Old Hall, London, 8 November 2018) para 3. 95 Ibid 4. 96 Sir Peter Millett, ‘Equity’s Place in the Law of Commerce’ (1998) 114 LQR 214. 97 Lord Sales, ‘The Interface between Contract and Equity’ (Lehane Memorial Lecture, Sydney, Sydney, 28 August 2019) 2. 98 Ibid 5. 99 Lord Briggs (n 91) para 2. 100 Ibid. Citing UBS AG v Kommunale Wasserwerke Leipzig GmbH [2017] EWCA Civ 1567 at [347]. 101 [2011] EWHC 1692 (Comm). 102 [2011] EWHC 692 (Comm). 103 Sir William Blair disagreed with the author on this point in a brief email exchange. He stated that he did not believe there was a conflict, arguably it works the other way in that there is a better chance of a sound award. Our exchange was brief, but we maintain our point. While there may indeed be a better chance of a sound award in the narrow confines of the arbitrated dispute, the overall effect would be to deny the courts to hear the case in which new precedent could be set. We maintain that the ‘net’ effect would be detrimental to the law. 104 Lord Briggs (n 91) para 59. Author notes * Sabur Malik is Head of Financial Regulation at Market FinReg, London, UK. The author wishes to thank Professor Jeffrey Golden and Sir William Blair for reviewing an early draft. © The Author(s) (2021). Published by Oxford University Press. All rights reserved. For permissions, please email: journals.permissions@oup.com This article is published and distributed under the terms of the Oxford University Press, Standard Journals Publication Model (https://academic.oup.com/journals/pages/open_access/funder_policies/chorus/standard_publication_model)
TI - The Empire Strikes Back: Derivatives disputes, the financial list, test case scheme and arbitration
JF - Capital Markets Law Journal
DO - 10.1093/cmlj/kmab017
DA - 2021-06-24
UR - https://www.deepdyve.com/lp/oxford-university-press/the-empire-strikes-back-derivatives-disputes-the-financial-list-test-N0jc8RN8RP
SP - 251
EP - 266
VL - 16
IS - 3
DP - DeepDyve
ER -