The difference isn’t always clear. Hedging (that is, taking steps to reduce exposure to risks, usually associated with market fluctuations) may have aspects of speculation (entering into transactions in the hope of making a profit, while risking adverse market movements), and vice versa. How to characterise some particular commodity options transactions arose in Standard Chartered Bank v Ceylon Petroleum Corp, [2012] EWCA Civ 1049. Ceylon Petroleum owed Standard and Chartered US$166 million under the options contracts (which was not how the company had hoped things would turn out), but argued that it lacked the corporate capacity to have entered into them in the first place. Ceylon Petroleum conceded that it had the capacity to hedge risks in oil markets to which it was exposed, but not to speculate in those markets with a view to profit (or to be exposed to the kinds of losses for which it was liable to the bank if the contracts were enforced).

The English Court of Appeal, having observed that hedging can be more or less speculative, and speculation more or less hedged, concluded that the whole thing was a false question – and one which will not be subject to objective criteria in any event. The real issue was whether the company had the corporate capacity to enter into these kinds of transactions (whether they were speculative hedges or hedged speculations). The legislation establishing Ceylon Petroleum in 1961 provides that the company’s objects are essentially commercial in character, specifically to function as the national importer and refiner of crude oil for Sri Lanka (formerly Ceylon). While there is a public interest aspect to the company’s objects, the legislature clearly intended Ceylon Petroleum to enter into the full range of transactions that any other oil importer and refiner would, which included the capacity to enter into the derivatives transactions with Standard and Chartered. It was also asking the wrong question to consider whether or not the transactions were prudent or imprudent, as the company appeared to be attempting to do. Judging the transactions in light of the meltdown in credit markets in 2008, which made them particularly unfavourable to the company, was ‘the wisdom of hindsight’; ‘if we were all as wise as hindsight teaches us to be, we would always prosper, but history relates a different lesson’, in the words of Moore-Bick LJ.

[Link available here].