Arbitration, Financial Services Disputes, and Derivatives

James Freeman of Allen & Overy has written a concise, informative and forward-looking article in the IBA’s publication Business Law International that offers a clear-eyed look at the state of arbitrated conflict resolution in the financial services industry and points to the Arbitration Guide recently published by the International Swaps and Derivatives Association (ISDA) as a path to change.

Freeman notes that, distinct from other commercial sectors, the financial services industry has “proven relatively immune to the lure of arbitration,” preferring litigation before national courts, for a variety of reasons.  Despite the absence of a global mechanism for enforcement of judgments, of the type that is offered for the enforcement of arbitral awards via the New York Convention, and despite promises of relative cost savings, efficiency and confidentiality, Freeman cites two predominant concerns favoring litigation of financial disputes.

The first is structural: that arbitrators may be commercially incompetent, that they have fewer procedural assurances, and that their powers may be limited (particularly in granting ex parte relief).  The infrequency of major banks’ refusal to comply with a judgment rendered by a court in a major commercial jurisdiction reinforces the absence of concern about that issue.

The second is conceptual: that arbitration is ill-suited to financial instruments that are intended to be traded.  Can an undertaking to arbitrate disputes, as part of an indenture or bond that is intended to be exchanged, transfer rights or obligations to subsequent purchasers of that instrument?  Can the holder of a security be bound by an agreement to arbitrate that is neither written nor signed by that holder?  In the case of transactions involving consumers, are agreements to arbitrate enforceable in all jurisdictions?

The ISDA Arbitration Guide departs from this set of concerns.  Traditionally ISDA Master Agreements have called for the jurisdiction of the English or New York courts.  Moreover, players in the derivatives and swaps market were largely uninformed of arbitration options, resulting in drafting errors in conforming the various clauses in the Master Agreements (such as service of process).

After a period of consultation, ISDA promulgated the 2013 ISDA Arbitration Guide, which provides a basic overview of the law and practice of international arbitration and provides 11 model clauses designed to be incorporated into a Master Agreement.  These clauses provide for arbitration pursuant to the rules of seven different providers, with seats in seven different venues.  In providing these clauses, the Guide “ensures avoidance of the common drafting errors” and also “incorporates what is essentially a standard arbitration clause for the arbitral institution specified.”   Moreover, a list of options is helpfully provided, to encourage drafters to consider questions of party joinder, consolidation, state players, criteria for arbitrator competence, and other issues.

Freedman concludes that “the Guide is a valuable tool to educate the derivatives markets about the characteristics of international arbitration and the circumstances in which it might best be employed.”  He also concludes that the provision of expert arbitrators (as is the aim of P.R.I.M.E. Finance, for example) might be the single dispositive factor in providing dispute resolution processes that meet the challenges posed by the users.

Many legal and business practitioners have begun to question the prevailing use of attorneys, rather than industry participants, as arbitrators in disputes involving commercial custom or industry practices.  Freeman’s description of the ISDA initiative is particularly tantalizing in that context, as it places commercial disputes before industry peers rather than those learned in law.

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