South Korean banks do not have to compensate companies that were sold knock-in-knock-out (Kiko) contracts the Seoul Central District Court ruled on Monday.
The court threw out an attempt by Soosan Heavy Industries to have currency option contracts with Citibank Korea and Woori annulled and to be compensated for the millions of Korean won lost over the last two years.
Soosan and as many as 500 other Korean companies claimed that they did not fully understand the mechanics of the contracts. Such claims have had varied success, but with this ruling, it appears that the court believes most were savvy enough to understand the risks.
Soosan had argued: “Kiko products were intentionally designed to benefit banks and cause their customers to suffer massive losses because they were structured unfairly.”
The suit is the latest of more than 100 pending law suits related to structured option contracts that have been filed since December. While some previous cases have been held for the plaintiffs, most have been left undecided until now. This latest ruling is expected to set a legal precedent.
The Kiko is not a hedge, but Korean exporters, if they were certain of KRW strength, saw them as a way to sell dollar receipts above the market. From 2005 such certainty was ubiquitous: although during the Asian financial crisis of 1997/98 the won fell to almost 2,000 to the dollar, by 2005 it had strengthened to 1,000. The consensus was overwhelming that it would strengthen further.
The Kiko contracts in question were generally of the form that the buyer could sell USD against the KRW at a better than market rate until the knock-out barrier was reached. However, if the KRW weakened and the knock-in barrier was triggered, the buyer would be obliged to sell USD, often a multiple of the original notional, at a strike lower than the market.
Through 2006 and 2007, as USD/KRW gradually declined to 900, the trades worked well for the Koreans and the use of the contracts became widespread. Then the financial crisis hit.
The won weakened and by October 2008 the USD/KRW rate stood at 1,500 and hundreds of exporting firms faced bankruptcy. As a result, up to 500 firms in South Korea brought lawsuits seeking to have the contracts invalidated.
The courts seem to have struck a blow for legal certainty by deciding that Kiko buyers must stick with the contracts through good times and bad. The court dismissed demands for compensation by saying: “Kiko contracts fundamentally include the dangers resulting from currency fluctuations. The banks will not be held responsible for the results of the unexpected worldwide financial plunge, which led to the depreciation of the won.”
Citibank said they, “welcome the court’s decision” but declined to comment further.
