This article addresses key questions concerning the use of international arbitration in cross-border financial transactions, and includes a discussion of the International Swaps and Derivatives Association (ISDA) September 2013 publication of seven model international arbitration clauses (Model Arbitration Clauses) for use with over-the counter (OTC) swaps and derivatives contracts using ISDA’s 2002 Master Agreement and 1992 Master Agreement (Multicurrency-Cross Border)(each, a Master Agreement).
Why is planning for disputes important?
Planning for disputes is a critically important component of managing the risks associated with any contract or transaction. That is particularly so in contracts with an international dimension, which raise important questions as to where, by whom and by which legal rules any disputes arising out of the contract will be resolved. The answers to those questions will have a critical impact on the merits and enforceability of any judgment or award, the cost and speed of resolving any disputes, as well as the legal certainty of the contract itself—and thus the risk that a contract will be performed according to its terms in the first place. Cross-border financial transactions, Master Agreements and swaps and derivatives contracts are no different, and in an increasingly globalised market for swaps and derivatives it is important for compliance, risk and legal professionals to focus on how disputes arising out of international financial contracts will be resolved.
What is international arbitration?
Arbitration, as is the case with litigation, is an adversarial system of dispute resolution. Arbitration is not mediation or conciliation, where a mediator or conciliator will seek to broker a negotiated settlement between the parties in dispute. In international arbitration proceedings, lawyers advocate their clients’ positions in written and oral submissions, and hearings are held where lawyers make oral arguments and conduct cross-examination of witnesses and experts. The arbitral tribunal (typically one or three arbitrators) then determines the dispute in accordance with legal principles in a reasoned award, analogous to a court judgment.
In contrast to litigation, however, arbitration is not public, disputes are not adjudicated by judges and hearings are not conducted in a court. Arbitration is a private process, disputes are heard before and determined by independent arbitrators (often appointed by the parties, or pursuant to a mechanism agreed by them) and arbitration hearings are held in hearing rooms at arbitration institutions or board rooms at law firms and, often, hotels. Procedural flexibility, informality, efficiency and finality (limited grounds to appeal arbitral awards) are the hallmarks of arbitration practice, unlike the rigid, formal procedures of most court systems. For further information regarding arbitration, please refer to DechertOnPoint, Financial Transactions and Arbitration.
Most international commercial arbitration agreements provide for arbitration under one of the several leading international arbitration institutions (discussed later in this article), each of which has its own set of arbitration rules to guide the conduct of the arbitration. The rules of these institutions provide only a framework for arbitral proceedings, leaving parties a wide degree of flexibility to agree on procedures appropriate for the dispute at hand.
What are the benefits of international arbitration for financial disputes?
Between 2011 and 2013, ISDA conducted a wide-ranging consultation of its members—including Dechert LLP—regarding the use of arbitration for disputes arising out of its Master Agreements. As noted in its 2013 ISDA Arbitration Guide (Arbitration Guide), it was evident from this consultation process that there was strong demand for an arbitration option for use with Master Agreements. ISDA’s extensive consultation and a recent 2013 survey of in-house counsel by Queen Mary University and PriceWaterhouseCoopers (PWC)1 have highlighted numerous reasons why international arbitration is gaining popularity with parties to cross-border financial transactions. The key benefits are seen as the following:
Enforcement premium. Arbitration benefits from a much more comprehensive regime for the cross-border enforcement of arbitral awards than exists for court judgments. As ISDA notes, “[s]ucceeding on the merits of a dispute may prove to be a pyrrhic victory if it is not possible to enforce the resulting judgment”. The “enforcement premium” offered by arbitration is that over 140 countries have ratified the 1958 UN Convention on Recognition and Enforcement of Foreign Arbitral Awards (New York Convention), which provides for the streamlined recognition and enforcement of arbitral awards in those jurisdictions, subject to limited exceptions. This is a particularly important consideration with counterparties in emerging markets.
Neutrality. When neither contracting party is prepared to submit to the jurisdiction of its counterparty's local courts, arbitration in a neutral third country may be the only acceptable forum. Counterparties in emerging jurisdictions are increasingly reluctant for disputes to be resolved in the English or New York courts.
Fairness. Agreeing to arbitration allows a party to avoid having to litigate in a jurisdiction in whose courts it does not have confidence. That may arise because of a court’s lack of expertise, delay or unfamiliar procedures or a perception of bias or corruption on the part of a judicial authority. Indeed, PWC’s 2013 survey noted that, for some in-house counsel, “fairness”—above all other considerations—is what companies look for in a dispute resolution mechanism: it was easier to explain to senior executives, or the board of directors, why the company had been unsuccessful if the board felt that the process had been fair. Arbitration, because of its neutrality, gives a sense of fairness that litigation in foreign courts sometimes cannot.
Privacy and confidentiality. International arbitration proceedings are conducted in private, but the confidentiality that attaches to arbitral proceedings will depend on the arbitration laws at the seat of the arbitration. If confidentiality of arbitral proceedings is important, this should be expressly specified in the arbitration agreement.
Party autonomy and procedural flexibility. By contrast to the highly regulated, detailed and formal procedures of most domestic legal systems, the arbitration rules of the leading international arbitration institutions provide only a framework for the procedures of the arbitration, leaving parties a very wide degree of flexibility to agree on procedures appropriate for the dispute at hand.
Expert arbitrators. Related to the freedom parties have to adapt the procedures of the arbitration to the dispute, most arbitration agreements where three (or more) arbitrators are to comprise the tribunal provide for each party to appoint one arbitrator with the chairperson of the tribunal to be agreed between them or between the two party-appointed arbitrators. This is an important right, but even more so in the technical subject area of financial and derivatives disputes. The ability to appoint an arbitrator with experience and expertise in complex financial products avoids the “roll of the dice” often associated with litigating in domestic courts, where judges may be generalist practitioners with no specialist expertise. If party appointment of arbitrators is important, this also should be expressly specified in the arbitration agreement.
Finality. Arbitration laws in most countries provide only limited grounds on which an international arbitral award may be challenged (for example, lack of jurisdiction or serious irregularity in the arbitration process, but not appeals on error of fact or law). Similarly, the New York Convention provides only limited grounds upon which an arbitral award may be refused recognition and enforcement (again, limited to jurisdictional and procedural grounds).
Industry standardization. Regulatory pressure for the development of clearing mechanisms for OTC derivatives may also encourage the use of arbitration. ISDA notes that the clearing rules of most of the world’s clearing houses (for securities and commodities trading, exchange-traded futures and options, and now many OTC derivatives) provide for disputes to be resolved by arbitration.
Indeed, more U.S. and non-U.S. counterparties (such as public pension plans and state-owned or controlled enterprises)—perhaps with more bargaining power than ever—may simply reject English or New York court litigation.
Litigating cross-border financial disputes in London and New York courts will no doubt continue to be effective and remain commonplace (perhaps because of the “lock-in” effects or stickiness of boilerplate terms and their familiarity2), but as PWC’s 2013 survey noted, over two-thirds of in-house counsel in financial services companies felt international arbitration is suited to resolving cross-border disputes in the industry.
Why has ISDA published model optional arbitration clauses for use with the Master Agreements, and what are the key elements of such clauses?
ISDA noted a number of reasons why arbitration, rather than the historically preferred English or New York court litigation, of swaps and derivatives disputes is likely to continue to increase, including the recent surge in the frequency with which arbitration clauses are included in a range of financial contracts, and in the number of financial disputes referred to arbitration. Arbitration is being increasingly used in relation to privately negotiated or OTC derivatives transactions entered into under master netting agreements, such as the Master Agreements.
Arbitration is also increasingly popular in Master Agreements involving parties established or operating in emerging market jurisdictions. As ISDA noted, not only is more business being transacted by western financial institutions in the emerging and frontier markets, intra-emerging market financial markets also now play a significant role in the world economy and will only continue to grow in importance. This globalisation of financial markets introduces important considerations for market participants when choosing the appropriate dispute resolution mechanism in their Master Agreements, and for cross-border transactions generally.
The increased interest in arbitration in cross-border finance is reflected in ISDA’s recent publication of a range of optional arbitration clauses, which are intended to form part of the Schedule to a Master Agreement. The Model Arbitration Clauses can be found in the Arbitration Guide, which supplements and amends the corresponding guidance in the ISDA User’s Guides. The key aspects are to provide for use of the leading institutional arbitration rules, offering numerous combinations of arbitral rules, governing laws and seats (Arbitration Guide, Appendices A-G).
Institutional arbitration rules. The institutional arbitration rules currently include the Rules of Arbitration of the International Chamber of Commerce (ICC), Arbitration Rules of the London Court of International Arbitration (LCIA), International Arbitration Rules of the American Arbitration Association—International Centre for Dispute Resolution (AAA-ICDR), Administered Arbitration Rules of the Hong Kong International Arbitration Centre (HKIAC), Arbitration Rules of the Singapore International Arbitration Centre (SIAC), Swiss Rules of International Arbitration (Swiss Arbitration) and the Panel of Recognised International Market Experts in Finance Arbitration Rules (P.R.I.M.E. Finance).
Governing law. The Model Arbitration Clauses provide for either English or New York governing law, historically the most popular among financial market participants.
Seat of arbitration. The Model Arbitration Clauses currently offer London, New York, Paris, Hong Kong, Singapore, Zurich, Geneva and The Hague as arbitral seats.
For further information, please refer to DechertOnPoint, ISDA Adopts Model Arbitration Clauses for Use with ISDA Master Agreements.
ISDA is careful to note that the published options were a response to member feedback, and inclusion in the Arbitration Guide is not an endorsement of the clauses (or combinations of rules, governing laws, and seats). Parties are free to modify the Model Arbitration Clauses as they devise and negotiate, and in all cases parties should seek appropriate legal advice to select the appropriate dispute resolution mechanisms for their circumstances.
Although not connected with ISDA, the increasing use of, and anticipated future demand for, arbitration of international financial disputes has also led to the establishment in early 2012 of a new financial dispute resolution institution—P.R.I.M.E Finance. The aim of P.R.I.M.E Finance is to provide a bespoke forum for the resolution of complex international financial disputes. Its offering includes a panel of specialist senior arbitrators who are experts in complex international financial disputes, customized arbitration rules, mediation and expert services. In the Arbitration Guide, ISDA has included in its Model Arbitration Clauses a clause that provides for arbitration under the P.R.I.M.E Finance Arbitration Rules.
How do I draft the right forum selection clause?
When it comes to drafting forum selection clauses for international contracts, one size does not fit all.
Commentators who suggest that either litigation or arbitration is—by definition—superior for financial market disputes ignore the practical legal and enforcement aspects of particular transactions. The most appropriate choices between litigation and arbitration, the governing law, the seat of the dispute, applicable institutional arbitration rules, etc. will need to be assessed on a case-by-case basis. Questions that must be considered include: Where am I likely to be most successful? Can I successfully enforce my judgment or award in jurisdiction ‘X’? Is confidentiality important? What are my options if I need to compromise on my preference? Are there issues of sovereign immunity? Do I need to provide for consolidation of disputes that may arise under related contracts (between the same or different parties)?
The ISDA’s Model Arbitration Clauses are to provide guidance only. As the Arbitration Guide notes, whether the Model Arbitration Clauses are adopted or market participants negotiate their own terms, in all cases parties should seek appropriate advice to select the desirable dispute resolution mechanisms for their circumstances.