Settlement of derivative contracts: Principles from legal precedents

• Published in: Tímarit um viðskipti og efnahagsmál
• Main Authors: Arngrímsson, Arnar Davíð, Sigurgeirsson, Hersir, Ásmundsson, Jakob Már
• Format: Article in Journal/Newspaper
• Language: Icelandic
• Published: Institute of Business Research 2018
• Subjects: Derivatives; default; bank liquidation; K12; K22; G01; G21; G23; Afleiður; afleiðusamningar; uppgjör afleiðusamninga; vanefnd; slitameðferð banka; Krona; Iceland
• Online Access: http://www.efnahagsmal.is/article/view/a.2018.15.1.1; https://doi.org/10.24122/tve.a.2018.15.1.1

Practices and regulation in international derivatives markets have historically been significantly influenced by legal precedents. The Icelandic derivatives market is relatively young and legal precedents were few and far between until the collapse of the banking system in 2008, which gave rise to a myriad of legal disputes having to do with the settlement of derivative contracts. The purpose of this article is to review the key findings of the Icelandic courts in this regard and attempt to identify some guiding principles. A review of 35 Supreme Court rulings is covered. The disputes are divided into seven categories: (1) permissions to engage in derivative transactions, (2) reference rate for foreign exchange, (3) calculation methods, (4) force majeure, (5) netting of payments, (6) reaction to the intervention of the Financial Supervisory Authority (FSA), and (7) impact of FSA intervention. Among some of the key findings is that everyone is entitled to engage in derivative contracts and that forward contracts on stocks are not considered a complex financial instrument. The foreign exchange rate of the Icelandic Krona, as determined by the Central Bank of Iceland, should be used for reference in settlement of derivatives if another reference is not explicitly stated. A derivatives contract that has been rolled, constitutes a new contract. The intervention of the FSA in taking over individual banks and its impact on the settlement of outstanding derivatives contracts for respective banks is reviewed, including the impact of how individual banks communicated with their counterparties. The conduct of individual banks towards their counterparties differed, which impacted the settlement. Landsbanki and Glitnir both sent their clients announcements informing that outstanding derivatives contracts would be closed. However, the wording in the case of Landsbanki was somewhat unclear and had to be interpreted in the context of how individual clients responded, resulting in varying methods being applied to individual ...