Arbitration and financial institutions: Revisiting dispute resolution options

Historically, financial institutions have tended to prefer dispute resolution clauses that provide for the submission of disputes to national courts and, in particular, the courts of leading financial centres such as London or New York. However, in recent years some financial institutions have begun to re-examine their approach to dispute resolution, at least for certain types of transaction, in light of developments in the financial markets.

The past few decades have been marked by the increasing complexity of financial products and greater sophistication in the structuring of transactions.  At the same time, there has been a standardization of documentation for certain types of transaction, such as derivatives and loans.  The Master Agreements of the International Swaps and Derivatives Association (“ISDA”) provide good examples.  In 2014, the notional amount of outstanding contracts for over-the-counter derivatives alone was estimated to be US$ 691 trillion, with more than 90% of this amount governed by ISDA Master Agreements (source: Bank for International Settlements).  In parallel to these developments, there has been an expansion of the operations of financial institutions throughout the world and, in particular, in emerging markets.

These developments have tested the premise that submission to the courts of the complex disputes that arise from financial transactions is the best solution.  Particularly in the case of transactions involving parties in emerging markets, litigating disputes in London or New York may not be appealing for a variety of reasons.  These include factors such as cost, language and, more importantly, the risk that a court judgment would be difficult to enforce or unenforceable in the jurisdiction(s) where the institution’s counterparty has assets.

At the same time, the relevant national courts may lack neutrality and/or judges with the requisite expertise.  With regard to widely used standardized agreements, such as the ISDA Master Agreements (which are governed by English or New York law), the interpretation of contractual terms can involve systemic risk in that other market players may have an interest in the outcome. Knowledge of market practice and consistency of decisions are, therefore, of considerable importance.  Arbitration can offer an attractive alternative, given the potential for the selection of arbitrators with appropriate experience and expertise to decide financial disputes.

Arbitration can offer an attractive alternative, given the potential for the selection of arbitrators with appropriate experience and expertise to decide financial disputes.

Resistance to arbitration on the part of financial institutions has been strong in the area of derivative transactions.  Nevertheless, in September 2013, after consultation with its members, ISDA issued its ISDA 2013 Arbitration Guide (the “ISDA Guide”), which includes an explanation of the key features of arbitration and a series of model arbitration clauses that provide for various combinations of governing laws, arbitral rules and seats. In comparing arbitration with court proceedings, the ISDA Guide cites the usual advantages of arbitration, such as enforcement under the New York Convention of 1958, neutrality and procedural flexibility, and draws attention to the availability of interim relief from an arbitral tribunal or an emergency arbitrator.

Commenting on the lack of default or summary judgments, one of the arguments against arbitration frequently advanced by banks, the ISDA Guide suggests that this disadvantage can be overstated, since arbitration may provide a quicker solution than the counterparty’s local courts (depending on the jurisdiction).  Even if they do not seek to provide for summary judgment (and are not equivalent), expedited proceedings available under the rules of some arbitral institutions can be helpful in resolving straightforward claims quickly.

Among the features of arbitration, the ISDA Guide mentions the privacy of proceedings and the possibility of building confidentiality into the process.  In certain cases, confidentiality may be appealing to a financial institution, such as where there is concern about the enforceability of a clause in a master agreement in a given situation.  However, the lack of publicly available precedents is frequently cited by banks as one of the drawbacks of arbitration. Confidentiality may, therefore, be an issue that requires consideration on a case by case basis in this area.

Derivative transactions are not, of course, the only area of banking activity where dispute resolution options are being revisited.  International financial institutions and bilateral development institutions have, for some time, been open to arbitration as a dispute resolution mechanism, given their transactions in emerging markets and with states.  In the private sector, where resistance to arbitration is perhaps more prevalent, arbitration is increasingly being considered for project finance documentation where a financial institution’s counterparty or its assets are located in a jurisdiction where the courts are considered to be unreliable.

Some commentators have observed that, even in the area of secured lending (either bilateral or syndicated loans), the belief that most defaults can be dealt with more effectively in court actions may be ceding ground where there is significant risk associated with the enforcement of a court judgment.  While recourse to the local courts may be compulsory with respect to certain types of security, arbitration may still be chosen for the resolution of disputes under other transaction documents. As many of these transactions involve multiple parties and agreements, careful attention to issues such as joinder and consolidation is needed in drafting dispute resolution clauses.

It is in this context that the ICC has selected arbitration and financial institutions for one of the industry-focused sessions at the ICC Miami Conference (Monday, 2 November, 3pm-6pm).  The programme will cover the use of arbitration in derivatives and structured finance, as well as in international financing, including the types of claim that arise and the challenges for counsel and arbitrators in this evolving area of dispute resolution.  The session will conclude with a review of recent developments in investment treaty arbitration involving financial institutions.

Patricia Peterson
Linklaters LLP, Paris Office

ICC Commission on Arbitration and ADR

Patricia Peterson is a member of the ICC Commission on Arbitration and ADR and a member of Task Force on Financial Institutions and International Arbitration.