Fear of Brexit provided a further boost to the already high number of businesses in the UK using derivatives to hedge FX risk last year.
Research published in July by East & Partners found that the use of FX options was universal among UK companies with turnover of £20 million to £100 million – up from less than 90% in 2015 – while more than 21% of businesses turning over less than £10 million were also using these products compared with just over 17% in April 2016.
Earlier this year it was revealed that UK clothing manufacturer Newstar Garments had claimed World First sold it derivatives of an “exceptionally high level of complexity” that led to losses in excess of £4 million. The only other case that has received comparable exposure was a dispute between Best Foods and Moneycorp that was settled out of court last year.
Neither World First nor Newstar Garments responded to Euromoney’s request for comment.
Abhishek Sachdev, CEO of Vedanta Hedging – which has advised a number of UK companies concerned about how they have been sold currency derivatives – says the issue of businesses being sold FX instruments that they simply didn’t understand, or need, first came to his attention about three years ago.
“In some cases these products were so complex and speculative that even FX specialists could not price them easily,” he says.
The sharp fall in sterling after the EU referendum vote left many smaller businesses, in particular, facing margin calls and prompted a spike in demand for advice, although Sachdev says companies with turnover in the hundreds of millions of pounds were also impacted.
He reckons he has received around two dozen enquiries since June, a twelvefold increase on the previous annual average.
Sachdev notes that every company he has advised has reached a confidential settlement with its bank or broker and expects the Newstar case to reach a similar conclusion.
“Despite being emboldened by their success in fighting interest-rate derivatives cases in court, banks and brokers will only let a case get that far if they are certain of success,” he says.
Duty of care
RPC senior associate Chris Ross notes that few banks or brokers will have accepted a contractual advisory duty to a small business client to whom they sell FX derivatives because they don’t want to limit the types of product they can sell.
|Chris Ross, RPC|
As a result, most claims are based on the duty of care argument – that the bank or broker has a duty to advise the customer on the best product for their requirements and that a derivative was not the best product.
The difficulty of taking a case that way is that banks and brokers are careful in the documentation they put in place, explains Ross.
“They will include disclaimers that even if the customer is given advice, the contract negates any liability for the outcome of that advice,” he says. “Courts usually recognise the validity of these types of contractual disclaimers even where it is accepted that the customer was given advice, so it is not a very claimant-friendly environment.”
A partner at another law firm agrees that the disclaimer clauses in standard terms and conditions represent an obstacle to litigation and adds that the costs involved would act as a deterrent to any claim worth less than seven figures.
Chris Towner, managing director of HiFM, says his firm’s approach to duty of care is firstly to make sure that the client understands the risk, secondly that they fully understand the alternatives so that they can make an informed decision and thirdly that they understand the scenarios of what could happen if they proceed with the chosen hedging tool.
UserCare Treasury Consultancy director Brian Welch suggests that sub-standard staff training and knowledge among some FX brokers has created an environment in which FX derivatives can be mis-sold.
“In addition, brokers are often completely unaware of the existence of FX codes of conduct and the distinction between retail and wholesale customers,” he says.
|Chris Towner, HiFM|
When asked whether the sale of currency derivatives represents a lucrative business for brokers, HiFM’s Towner observes that it takes much longer to make sure that the client fully understands the products on offer and the accompanying risks, and that currency derivatives – unlike spot contracts – take up credit lines.
However, he also acknowledges that the amount of revenue that a broker can make from currency derivatives can be substantially higher than the potential revenue from a spot contract.
Vedanta’s Sachdev is keen to stress that he is not hostile to the use of derivatives or FX brokers, observing that they provide a useful service to businesses with FX exposure.
“However, it is clear that many customers did not understand that they would come unstuck if the market moved against them,” he concludes.