The International Swaps and Derivatives Association (“ISDA“) is undertaking a consultation on the use of arbitration under the ISDA Master Agreements, the market leading standard form agreements for documenting swaps and other derivative transactions.
As ISDA’s consultation documents point out, recent years have seen an increase in the use of arbitration as a means of resolving disputes in the financial sector, an area where English or New York court jurisdiction has traditionally been favoured by market participants. This trend is driven by globalisation and the increasing prevalence of cross-border finance transactions, particularly those involving emerging markets jurisdictions. It is also driven by the perceived advantages of arbitration, most notably the availability of enforcement mechanisms for arbitration awards under the New York Convention that, for the most part, are superior to the enforcement options available for court judgments.
The period for submission of written responses closed in December 2011, and ISDA recently (in June 2012) hosted a meeting in Singapore as part of the consultation process. We understand that further meetings will be held in the coming months. The outcome of the consultation therefore remains to be seen. However, it appears likely that ISDA will at least proceed to offer one or more model arbitration clauses for use with the ISDA Master Agreements. In any case, disputes relating to the derivatives markets (and the financial sector more generally) are likely to be an increasingly prominent feature of the arbitration landscape in years to come.
The ISDA Consultation
ISDA has identified three current issues regarding the use of arbitration in derivatives transactions, and has proposed potential policy options to address each issue as follows:
- Arbitration clauses: ISDA has noted that unnecessary difficulties have arisen in practice from defective and poorly drafted arbitration clauses being inserted into ISDA and other agreements. Accordingly, ISDA has proposed that it publish one or more model arbitration clauses for use with the ISDA Master Agreements. It has sought members’ views on whether this is worthwhile, and, if so:
- Which arbitral seat(s) and institution(s) should be included. It is worth noting that one of the options under consideration is the recently established PRIME Finance, although ISDA has stressed that it is neutral as to the various arbitral institutions on offer;
- Whether its model clauses should include an “optional” arbitration clause. Optional arbitration clauses give one or both parties (but typically just the finance parties) the right to choose between arbitration and litigation once a dispute has actually arisen. While such clauses provide flexibility, they are not without risk, and there are concerns about their enforceability in a number of jurisdictions; and
- Whether the model clause(s) should provide for the use of “fast-track” arbitration procedures. ISDA has suggested that this might be one way to address what is perceived as the main disadvantage of arbitration as a means of resolving derivatives related disputes, namely the lack of any default or summary judgment mechanisms of the kind available in many court systems. Such mechanisms can make it quicker and more straightforward to obtain judgment debts against respondents that choose not to participate in the proceedings, or that raise only very weak defences to a claim. However, as ISDA has pointed out, this disadvantage is often given undue prominence, and to some extent can be addressed through the use of fast-track arbitration procedures and/or the use of optional arbitration clauses.
- Arbitrators’ qualifications: ISDA has also noted that the pool of arbitrators with substantial experience of the derivatives markets is relatively limited. ISDA has sought members’ views on what steps it might take to resolve this issue, but has noted that it expects the number of arbitrators with derivatives experience to grow over time as more derivatives-related disputes are referred to arbitration.
- Developing jurisprudence on the ISDA Master Agreements: Lastly, ISDA has noted that because arbitral awards (unlike court judgments) are private and lack precedential value, the growth in the number of derivatives-related cases that are referred to arbitration may hinder the development of a body of case law on the interpretation of the ISDA Master Agreements. Such case law can help to provide certainty and guidance for the market as a whole. Accordingly, ISDA has sought feedback from members on the significance of this issue and how best to address it. One possibility mentioned in the ISDA consultation is discussing with the main arbitral institutions what mechanisms might be put in place to allow awards dealing with sufficiently important issues to be published in redacted form (ie excluding party names and other confidential information). Some arbitral institutions (notably the ICC) already have a practice of publishing redacted versions of important decisions, and are therefore likely to be receptive to any such proposal from ISDA.
Whatever the outcome, the ISDA consultation indicates a trend towards the more widespread use of arbitration for dispute resolution in the financial sector, and in the derivatives markets in particular. This trend, along with the risk of being caught out by an unenforceable judgment should the traditional option of English or New York court jurisdiction be selected, makes it extremely important that participants in the derivatives markets are familiar with the available dispute resolution options. However, there is no “one size fits all” approach, and the appropriate choice will depend on a number of variables (such as the parties and jurisdictions involved) which can often interact in a complex way. This makes it advisable to seek specialist advice when dealing with dispute resolution provisions for derivatives transactions.