By Richard Tyler
The world’s largest law firms have spent the past 12 months engaged in a bloody battle over control of legal cyberspace.
UK giant Linklaters edged ahead for a while with the launch of Blue Flag Confirms, which allows derivatives transaction managers to automatically build “confirm” documents on-line automatically.
Not to be outdone, arch-rivals Clifford Chance and Allen&Overy both revealed internet-based transaction management products – dubbed “virtual deal rooms” for cross-border transactions.
Allen&Overy’s newchange.com also came with an attractive new “modular” documentation system, an innovation the firm claimed cuts the time taken to draft documents by 95%.
Then in September, Linklaters jumped ahead with its own deal room, clients@Linklaters, that for the first time gives clients access to original documents stored in its databases.
Last month the battle entered a new phase when for the first time one of the big firms, Allen&Overy, agreed to sell its proprietary know-how on the legal risks of collateralizing derivatives to a JP Morgan on-line derivative services spin-off called Cygnifi.
Cygnifi’s legal risk collateral management product is called Trinity, which offers regularly updated summaries of legal memoranda on the risk associated with collateralized derivatives, including enforceability and documentation.
When fully up and running, Trinity will cover 55 jurisdictions, including core trading zones such as Belgium, Germany and the UK as well as countries where there has been little if any research before, such as India and Monaco.
On top of this purely legal material, Trinity adds its in-house know-how to offer commercial templates for executing derivatives and a new country rating system it dubs its “collateral confidence factor”, which draws on local factors such as the reliability of the courts, to come up with a ranking from A to F. Russia and China are among those ranked F.
Banks have been using collateral to reduce their exposure to over-the-counter derivative credits since the late 1980s, but often they have not assessed how much of the credit risk is merely replaced by legal and operating risk. Cautious companies and institutions have tried to assess this risk in the past, but often only to a degree, as conducting comprehensive surveys is costly in time and money.
Allen&Overy’s derivatives partner, Simon Haddock, explains the process. “If a financial institution wants to start doing derivatives in new jurisdictions it will need to get a clear analysis of the legal risks,” he says. “It could cost them anything between $10,000 and $30,000 per jurisdiction to get highly complicated opinions that could take between two weeks and three months to come through. They will then need to collate the data from all the jurisdictions and interpret it, which could cost, depending on the jurisdictions, in excess of £100,000. The entire exercise could take more than six months and cost more than $1 million.” He adds: “Even when they do it, they don’t always get the product they want. It is only by asking questions in the right way that you get answers back that can create data that is useful to your business.”
Citibank, Goldman Sachs, Morgan Stanley, ABN Amro and Euroclear are all believed to have conducted reviews of specific jurisdictions.
There are also the opinion surveys periodically commissioned by the International Swaps&Derivatives Association, but many banks see this research as offering only the pure law and not the fundamentally important legal interpretation and commercial application.
JP Morgan’s global head of collateral management, Michael Clarke, conducted a root-and-branch review some three years ago and the results of this exercise were to form the basis for Trinity. At the time he managed a 70-strong collateral team – Wall Street’s largest – looking after $22 billion of collateral generated from some 150,000 transactions and based on 1,600 different collateralized agreements. Clarke held a beauty parade for an international law firm to handle the project and Allen&Overy beat two US and UK rivals to land the work.
The firm agreed to commit one senior derivatives associate – Dean Naumowicz in-house at JP Morgan – and to have another – Julie Spencer – working full time on the project from London. Allen&Overy instructed counsel in the jurisdictions it lacked sufficient local market knowledge of to assess the relevant law and then compiled and interpreted this raw data, transferring it onto databases and heat maps.
The whole process took two and a half years and cost JP Morgan several million dollars. It then added its own in-house expertise to assess the commercial implications of the research. “You have to take a risk management view on how happy you are with the data,” says Clarke. His involvement in this exercise formed the basis for Trinity and after its parent, Cygnifi, secured first-round financing earlier this year the service was launched.
Using its “carrot and mallet” persuasion technique, Trinity has so far secured agreement from 12 of the law firms that compiled the original research to participate and is working hard to win the others round.
Clarke says the negotiations are taking time for a variety of reasons: “Many law firms are not aware of the commercial potential of the internet. This is all so novel to the type of work they typically do in their marketplace, if you just call them up they wouldn’t know what the product was.”
He says some firms, for example the Swedish and Irish ones, were very e-commerce aware. Others had concerns about the nature of the collaboration as in many cases, for instance Allen&Overy and Hengeler Mueller Weitzel Wirtz in Germany, the firms involved are direct competitors.
The New York review has been completed but Trinity is still in negotiations with the white shoe firm involved to buy the know-how.
But why has Allen&Overy taken this route and not sold its technical expertise over the internet using its existing newchange platform. Haddock says: “It is the way the market has reacted. Why resist it, why not grasp it and provide a product that can be sold over and over again?”
Allen&Overy has not locked itself into any exclusivity agreement and its know-how could well appear for sale on other platforms.
Of course, if Trinity takes off then it will need help desks, regular updates – “a huge legal input,” as Haddock describes it – which Allen&Overy would clearly profit from. Haddock says: “What the market is looking for is an independent platform and Cygnifi is a good bet.”
But he adds: “Trinity is just the tip of the iceberg.”
