Mini budget drama: UK banks face wave of ‘exotic’ forex derivatives claims after collapse of Pound
Legal disputes between banks and their business customers are expected following the collapse in the value of sterling against the U.S. Dollar and the volatility of other currencies.
The dramatic volatility of currencies over the last few months will have led to many businesses facing substantial losses from complex Forex derivatives contracts they had entered into on the understanding they were an appropriate means of hedging their Forex exposure.
While businesses commonly enter into forex hedging arrangements to reduce the financial impact of currency fluctuations, many more exotic derivatives will perform in unexpected ways during periods of high volatility.
These exotic derivatives usually have an element of gearing which means that if the customer is on the “wrong side” of the trade they have to pay the bank a sum based on a multiple of the original sum, according to international law firm RPC.
Further, the customer’s potential gains (and the bank’s losses) are capped by a “knock out” provision, which terminates the transaction if a certain “trigger” point is reached, the lawyers told CityAM
However, there is no equivalent “knock out” provision to protect the customer and the potential losses (and the bank’s profits) are, therefore, unlimited.
Forex derivatives
Complex forex derivative products, such as Target Redemption Forwards (TRFs or TARFs) or Target Redemption Notes (TRNs), are said to be unnecessarily complex and sophisticated for many businesses and may be a source of mis- selling claims.
The International Monetary Fund has previously described these kinds of forex derivatives as ‘products from hell” and warned that they do not properly function as a hedge.
The volatility in Pound Sterling following the UK’s mini-budget on 23 September 2022 caused major disruption to international businesses that bought Forex derivatives in an effort to manage currency exposure.
Pound Sterling fell to as low as $1.03 against the U.S. Dollar and €1.08 against the Euro in September 2022.
Even though Sterling has recovered since, it is unlikely to have helped businesses caught on the wrong side at the time.
Mini-Budget drama
The recent mini-Budget saw Sterling fall to its lowest level against the dollar since 1985 and the Dollar was similarly at the strongest levels against a basket of currencies since 1995.
The collapse in the Euro versus the dollar is also likely to lead to claims where the derivative involves that pair of currencies.
“Exotic FX derivative products, rather than a low-risk hedge, can represent a high-stakes gamble,” explained RPC Partner Jonathan Cary.
“We’ve recently experienced incredibly turbulent market conditions,” Cary told CityAM today.
“It is apparent that many of the banks’ own sales teams don’t themselves fully understand these products or they have had little real regard to whether they are suitable for their clients.”
Jonathan Cary
“We anticipate that there have been major losses suffered as a consequence of the remarkable asymmetry of risk and reward in these products.”
“Customers exposed to such losses will be asking challenging questions about how these products were sold, whether they were suitable for their purposes and whether the banks made them fully aware of the significant risks.
Cary explained that several cases involving mis-selling by banks to overseas companies will be heard in the English courts as many derivative contracts provide for English law and jurisdiction.