Holtrop S.L.P. blog

The informative session on market derivatives organized by APPA on 20th July in Madrid  proved to be very instructive. The focus of the seminar was on one specific type of derivative and one type of consumer, namely, swaps and renewables producers.

It is well known that swaps are complex products, not only because the law says so itself, but because of their very nature. Indeed, there are implicit swaps (which are contained in another contract, typically a credit or loan agreement) and explicit swaps (which have been contracted separately), furthermore, they can be future, exotic, generic and they may be subscribed in organized markets or in the over the counter market (OTC); ninety percent of swaps are subscribed in these latter markets. The International Swap and Derivatives Association has indicated that for OTC markets, only parties in equal conditions can operate in them. While the Spanish Stock Market Law assumes that a party with a certain business volume (20-40M€) can be considered professional, assuming that this automatically makes them experts in financial derivatives, the truth is that it is impossible to negotiate under equal conditions a product of which something as essential as the price, is unknown to one of the parties. May it be noted here that, only for the IRS generic swap there exists are daily data that allows, those with access to platforms such as Bloomberg, to analyse their fluctuation.

Therefore, while swaps and derivatives are not intrinsically harmful, the use that they have been given, particularly in relation to the obtention of financing for renewable installations, has had disastrous consequences for many. The reasons for this are several: it could be that it was not the appropriate product to meet the client’s needs, that it was not suitable for the type of client (non-professional), that the product was badly designed (which generates an over-coverage and creates a new risk), or because of the evolution of the markets, for which there is a clear case of information asymmetry between the parties.

Thus, in order to comply with the obligation to provide sufficient and adequate information, the bank must give the client a reasonable valuation of the price of the derivative and its cancellation cost, as well as an efficiency estimation and a diagram with sensitivity indicators. All of this of course, prior to subscription. What the client would realise with these tools is that he was becoming the insurer of the bank. If the purpose was to cover a volatility risk in interest rates, surely there were much simpler ways of doing so, namely, by setting floors and caps to their fluctuation. Nevertheless, they chose to offset one “risk” by generating an even bigger one for the client.

Moving now onto a more practical level, what can we do if we are affected by a harmful swap? As we announced in May (here), the National Comission of Markets and Competition (CNMC) is investigating 4 major banks for collusive agreements in relation to the commercialization of these types of derivatives. A possibility for those who have subscribed swaps with those banks would be to wait for the outcome of the CNMC’s investigation and, if favourable, claim restitution before the Commercial Courts, petitioning them to apply arts. 1 and 2 of the Spanish Law in Defence of Competition, based on art. 1 of Directive 2014/104/EU, which is currently in the process of transposition into Spanish law. According to the Directive “anyone who has suffered harm caused by an infringement of competition law by an undertaking or by an association of undertakings can effectively exercise the right to claim full compensation for that harm from that undertaking or association”. The second possibility available, and the most direct, consists in filing a suit before the civil jurisdiction invoking the breach of the duties of information to be provided by the bank, for which there is extensive case law. Indeed, financial entities are not only bound by their contractual duties, they also have to meticulously comply with all the banking legislation, which includes the said duty of information to the clients. In all cases, in order for our claim to be successful, it is essential that we quantify the harm caused by the swap, as well as providing a detailed description of the duties breached by the counterparty.

To facilitate these kind of claims, litigation funds have recently taken prominence (see news). These funds offer the plaintiff the necessary resources to litigate in exchange for an agreed share of the proceeds of the claim. From Holtrop we are already working to assess these financing opportunities, which would entail a collaboration between us and the litigation fund, allowing us to provide a tailored service to our clients’ needs.