14 August 2014

The ISDA-fication of arbitration

King & Wood Mallesons (London) lunches with Dr Peter Werner, Senior Director, ISDA

The International Swaps and Derivatives Association (ISDA) is the world’s leading trade association for participants in the market for over the counter derivatives. One of its crowning achievements has been the widespread adoption of its “master agreements”, which now form the standard template for derivative transactions worldwide. In 2013, ISDA adopted a model arbitration clause for use in its master agreements. King & Wood Mallesons meets with Dr Peter Werner, Senior Director of ISDA.

Welcome Peter. To start, perhaps you can tell us a bit about yourself?

I am a lawyer qualified in Germany and with an academic background in international law. At ISDA I am responsible for international and regional legal policy. I represent ISDA in international organisations such as UNIDROIT, UNCITRAL and the Hague Conference on Private International Law. I have particular responsibility for ISDA documentation in the fields of energy and commodities; and in developing products (such as Islamic finance).

Our first question for you about the introduction of model arbitration clauses to the Master Agreement (“MA”) is: why now?

We were receiving an increasing number of questions from our members about how to "ISDA-ify" suitable arbitration clauses, so it was clear to us that there was an appetite for ISDA to look into whether we should provide general guidance to our members. We began a wider consultation and were a little surprised at how many members gave feedback – it seems that a large proportion of members, including members who had never been that vocal before - were very vocal about arbitration.

That doesn't surprise us, the arbitration world seems to be full of people who like to express their opinions about the subject... So the guidance was all driven by member demand?

Yes, but then this is how ISDA works. ISDA itself has no “view” on the merits or otherwise of arbitration.

We went back to discussions around the drafting of the 1992 and 2002 MAs to see why arbitration was not included as an option then. It appears not to have been raised as an issue back then. Things have changed enormously in the last decade.

The explanation is probably to be found in where ISDA came from. It was originally an association of banks which traded derivatives with each other. They were typically based in London or New York, so that made the dispute resolution clauses easy – the courts of one or either jurisdiction were suitable for the resolution of the vast majority of disputes.

What has changed since then? First, ISDA has far more corporate members – over 845 members from 65 countries of which approximately 30 per cent are corporates. It is not just banks who are the counter parties, it could be sovereign or semi-sovereign entities, or MNCs. Also, there is far more diversity in relation to where our members are based and the markets in which they were active. For instance, the MAs are increasingly used by parties in emerging markets. Finally, many other business sectors regularly use arbitration, so it is familiar to many non-bank counter-parties, for example in shipping, energy, commodities or Islamic finance. All of these factors created a trend towards parties wanting to use arbitration in their derivative contracts.

As arbitration practitioners, it has always seemed odd to us that this was a recent development. As you say, many industries with similar characteristics (cross border transactions, importance of effective enforcement) are much more regular users.

P Wood in his book International Loans, Bonds and Securities Regulation famously observed that banks do not like arbitration, but ISDA’s consultation has shown that there has been a much wider acceptance of arbitration as a suitable option for derivative disputes, certainly among market participants in worldwide cross-border derivative transactions generally, and probably more generally after the global financial crisis. For example Klaus Peter Berger, who participated as an academic expert on the ISDA Working Group, has been a voice in support of arbitration for financial disputes, particularly on a business-to-business basis.

One thing that the ISDA consultation resulted in, that we are really proud of, is getting different departments within banks and trading companies across all regions to consult internally about these issues. For instance, derivative traders and derivative lawyers may be isolated from other parts of their organisation. As part of our consultation we arranged meetings where these internal teams spoke together. It was interesting to hear views expressed about arbitration from different perspectives in the same bank.

We've been including bespoke arbitration options in MAs for our clients for some time now, predominantly where parties are based in the Middle East or in Russia or the CIS. The key impetus we have seen has been for better enforcement options and to keep disputes out of courts that may perhaps lack the necessary expertise. From the responses to ISDA’s consultation, would you agree these were the key reasons for selecting arbitration or was there anything more left field?

We all know that outside the European Union and away from the reach of the Judgments Regulation and Lugano Convention, cross border enforcement is a real issue. The New York Convention on the Recognition and Enforcement of Arbitral Awards has been an extremely effective solution to this as regards international arbitration, but there is no equivalent for court judgments (at least not unless or until the Hague Choice of Courts Convention enters into force –which might happen later this year when the EU ratifies it).

Parties can be motivated by a number of other issues. They may prefer that the dispute is resolved outside the local court system, particularly where a sovereign or quasi-sovereign entity is involved. Regardless of the outcome, the negative publicity accompanying a court decision and the whole process can also be perceived in a negative way to the parties involved. Parties may also prefer to appoint their own arbitrators in order to ensure that the decision maker have an understanding of the products in dispute. This is important, although it is encouraging to see courts actively seeking to better their understanding of the products and the markets. I have personally been involved in delivering some training to the Russian judiciary of the Supreme Court (Arbitrazh) Court, at their invitation.

The lack of understanding about these products is not just an issue for courts; we noticed that one of the matters in the ISDA policy papers was the need to educate arbitrators. We wondered if this was why P.R.I.M.E. Finance was listed as an option, with its panel of market experts.

Subject to the disclaimer that I am a member of P.R.I.M.E.’s panel of experts in capital markets, I agree. I think the panel of experts, whether to sit as arbitrators, or as mediators or to be appointed as experts, is of real interest to market participants.

We included P.R.I.M.E. as an option in our model clauses due to demand from our members, although it will obviously take time before we see arbitrations arising from agreements that include a P.R.I.M.E. Finance arbitration clause.

This seems a good moment to move on to the model clauses themselves. Most of our readers will know that there is a "pick and choose" menu of suggested clauses, with different institutional rules and governing laws, ranging from SIAC to ICC to P.R.I.M.E. Finance.

Our German colleagues have asked us to ask why no German arbitral institutions made the cut.

There are obviously an enormous number of options out there for arbitration institutions. We had to be selective. After consultation of approximately 65 member firms across the globe, we chose the options (i.e. seats, governing laws and applicable rules) on the basis of what our members wanted and needed based on practical experience from derivative cases that involved arbitration or are likely to become subject to arbitration proceedings in the near future. There was a lot of lobbying by lawyers and arbitral institutions from a wide range of countries too, but we had to concentrate on practical needs.

We have drafted a lot of arbitration clauses adopting the rules of regional arbitration centres, such as the Dubai International Arbitration Centre, for MAs (DIAC seems to be used a lot in the Middle East), although it is usually the case that disputes under such MAs end up being mediated.

Equally, we included Switzerland due to the increasing number of MAs being entered into by private high net worth individuals and private banks. The use of the MAs in this way gives rise to a whole host of other issues of course, just as when they are used by funds, but it does demonstrate the flexibility of the MA.

As an international law firm headquartered in Asia, we have to ask you about what feedback you received from China and whether there was any consideration of a Chinese institution being included?

The truth is that ISDA had very few responses to its consultation from the PRC, and most of those where from Hong Kong. China has its own local derivative contract standard form that provides for CIETAC arbitration [And CIETAC has its own special rules for financial disputes].

The real issue is increased legal certainty regarding the legal framework for derivatives in PRC (and not only in some newly established free zones), for instance regarding the enforceability of close-out netting and financial collateral arrangements. Another issue will be if and when the RMB becomes fully tradable and we get international RMB derivative contracts.

Looking more generally though, Asia as a whole is a rapidly growing derivative market. I was there in the spring and summer of this year and there was a real interest in and knowledge of the ISDA arbitration guide. As to preferred dispute resolution clauses for Asian parties, the responses from Asia suggested that different countries have different dispute preferences. For instance, we understand that in some transactions with South Korea and Japan parties often choose New York law; whereas transactions entered into with counterparties in other Asian jurisdictions lean towards English law. It seems that Singapore is really becoming a preferred choice in terms of arbitral centre for derivatives disputes.

The ISDA Arbitration Guide is well drafted and contains some useful model clauses. Do you find that these are adopted religiously, or do parties often chose a seat or set of rules outside the ISDA list?

It is good to know that people like the Guide! Yes, our members can and do adapt or entirely depart from the models provided – they are only guidance. In Australia it is common to adopt Australian law and I was recently in Stockholm where I spoke to lawyers who were creating an ISDA-fied SCC option. And we have seen DIFC-LCIA arbitration clauses where there are GCC parties.

Are we seeing a move away from the supremacy of English and New York law?

That may overstate the position - at least for international cross border contracts. For inter-American contracts, such as US-Brazil, we still usually see New York law, but for the vast majority of other international MAs, I would say more than 80 percent, they use English law.

It really is this country's best export. Peter, it’s been a pleasure. Thanks for taking the time to give us some more insight into the new model clauses.

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