English courts back ISDA Master Agreement in FX dispute

Out-Law Analysis | 21 Aug 2020 | 4:35 pm | 4 min. read

The terms of the ISDA Master Agreement take precedence over a bank's general terms of business where these are in conflict, the Court of Appeal in London has confirmed, giving certainty to financial traders.

The interaction between general terms of business and individual trades is often a thorny issue. General terms will tend to be written in more friendly or aspirational language, whereas in a particular trade it may suit one party or the other to be more hard-nosed by reference to the specific terms of that trade.

The ISDA Master Agreement is the most widely used standard form contract in finance, so new decisions about it are generally interesting to the market. Users of the Master Agreement can elect whether to apply English or New York law, and decisions in both jurisdictions tend to inform each other.

Both the English and New York courts have repeatedly stated that the Master Agreement should be construed so as to create certainty. The courts are well aware of the huge number of trades taking place globally on the same basic terms, so giving any kind of 'novel' meaning to the market standard documents could have a very unpredictable effect. For this reason, they tend to approach novel arguments coming out of individual 'hard luck' stories with great caution.

Hawthorne Michael

Mike Hawthorne

Legal Director

The courts are well aware of the huge number of trades taking place globally on the same basic terms, so giving any kind of 'novel' meaning to the market standard documents could have a very unpredictable effect.

The case arose in the context of the Swiss 'flash crash' of January 2015. The customer, CHF Clearing Ltd, placed a number of EUR/CHF 'next available price' spot orders at 9.47am on 15 January 2015, 17 minutes after the Swiss National Bank 'de-pegged' the Swiss Franc from the Euro. The exchange rate was extremely volatile in the short period after the announcement, stabilising at around 1.00 by the end of the day. The main trading platform declared an "official low" of 0.85 in the day's trading.

Both CHF Clearing and the bank, Merrill Lynch, executed the trades through automated systems, with Merrill Lynch filing the orders at an average rate of 0.182. The customer placed trades with other banks during the same period of volatility, with those banks all agreeing to re-book the trades at the day's official low of 0.85. Merrill Lynch, however, insisted that the customer honour the trades at 0.182.

CHF Clearing argued that there was a recognised practice in the foreign exchange (FX) market that, when trades were executed outside the authenticated market range, the parties should immediately either adjust the price to the relevant end of the authenticated range or cancel the trades altogether. This practice is in fact recognised for over-the-counter party-to-party transactions in the 2013 edition of the Financial Markets Association Model Code, which states: "Trades which occur at off-market rates should, by agreement between the two counterparts and as soon as practically possible, either be cancelled or have their rate modified to be at an appropriate market rate".

The difficulty for CHF Clearing was in proving that market practice was incorporated into the contractual terms of the trades.

The preamble to Merrill Lynch's terms of business stated that these applied to all investment and connected business which the bank might carry on with the customer, "subject to any documentation relating to a specific transaction or transactions between the bank and the customer".

Clause 7 in the terms of business then said: "All transactions are subject to all applicable laws, rules, regulations howsoever applying and, where relevant, the market practice of any exchange, market, trading venue and/or any clearing house and including the FSA Rules (together the 'applicable rules'). In the event of any conflict between these Terms and any applicable rules, the applicable rules shall prevail".

The Court of Appeal had to decide whether the primary source of the obligations was the terms of the trades or the terms of business. It did so by giving primacy to the preamble in the terms of business, creating a hierarchy of rules as follows:

  • first, the terms of the trades - in this case, the ISDA documents - as the terms of business are said in the preamble to be "subject to any documentation relating to a specific transaction or transactions";
  • second, applicable laws, rules, regulations and market practices as per clause 7 of the terms of business.

It could be argued that this is the wrong way round, because the trades must surely have been subject to all applicable laws; or that reading the contract in this way renders clause 7 largely meaningless. It is certainly understandable why the customer in this case was aggrieved. Nonetheless, the Court of Appeal had to resolve it one way or the other, and the way in which it did does create a kind of certainty, albeit not the one the customer wanted.

In its judgment, the court made the policy reasons it had in mind when it decided to give primacy to the ISDA terms clear.

The court said: "[W]hilst it was certainly open for the parties to agree to vary, amend or supplement the ISDA Master Agreement, any alleged agreement to such effect must be considered in the context that the parties had adopted a detailed contractual regime, incorporating industry norms and practices and intended to be a single comprehensive contract for all subsequent transactions".

"The suggestion that the parties had agreed to incorporate 'market practice' generally, even though not reflected in the ISDA Master Agreement and, indeed, overriding its provisions, must be treated with considerable caution. Such a result would undermine the objectives of clarity, certainty and predictability identified by [the courts in previous case law on the ISDA Master Agreement]," it said.

No doubt this will not be the last time that a party in a 'hard case' tries to recoup its losses by an appeal to incorporate external terms in the market standard documents, but the trend - in this jurisdiction at least - is clearly against it.