During the 2008–9 global financial crisis, credit default swaps created conduits in the financial system which facilitated the transmission of systemic risk. In response, the Financial Stability Board recommended over-the-counter derivative clearing through a central clearing counterparty. Although the Securities and Futures Commission is the designated supervisor and resolution authority for Hong Kong’s central clearing counterparty, OTC Clear, its supervisory ambit, capacity, and powers are insufficient to mitigate systemic risk and manage financial stability. This chapter argues that a securities supervisor is not the optimal supervisor or resolution authority for OTC Clear. Central clearing counterparties require credit and liquidity risk management which aligns more with banking supervision and central banking. This is supported by the dominance of foreign exchange and interest rate derivatives being traded in Hong Kong. The optimal resolution authority for OTC Clear is the Hong Kong Monetary Authority, being the resolution authority for systemically important banks, having monetary authority expertise that aligns with foreign exchange and interest rate risks, experience in mitigating credit and liquidity risks, and being designed to manage financial stability.

The preceding chapter showed the piecemeal nature of regulatory protections for participants in the derivatives markets and explained how it has been justified on the basis that an alternative means of redress is available, namely private claims for mis-selling based upon ‘contract and negligence’. This chapter explores the reality of this type of private law claim. The argument focuses on those claims that are typically deployed by participants in the OTC derivatives markets and on the patterns that emerge from these mis-selling cases. The next chapter considers the related topic of contractual defences relied upon in this context. Together, these two chapters demonstrate why there have been so few successful mis-selling claims and question the assumptions behind the prevailing regulatory scheme.

This chapter addresses the vital issue of which law which should apply to substantive proceedings between parties to derivatives contracts. The discussion presumes that the jurisdiction of the English courts has been chosen or otherwise settled, as discussed in the Chapter 8. Accordingly, the impact that a contractual choice of law may have on disputes about jurisdiction is not addressed here.

To challenge a contractual counterparty’s decision-making is to invoke different and (for financial market participants) less familiar types of legal standards to those examined thus far, requiring a different type of scrutiny by the courts and raising questions about the boundaries between public and private law.

‘Over-the-counter’ (‘OTC’) derivatives have attracted unprecedented levels of scrutiny since the global financial crisis which broke out in 2007–8. Yet this would be the wrong place to start in order to understand the modern derivatives markets and the courts’ role in relation to them. This chapter argues that in order to understand post-crisis developments in the OTC markets, including the unprecedented surge of litigation after 2008, it is necessary to place these developments in historical, legal and regulatory context. Having set out important definitions and discussed the main uses of derivatives by way of introduction, the chapter explores the evolution of the modern derivatives markets, highlighting the particular significance of contractual standardisation and market diversification.

The previous chapter explored the pivotal role of the ISDA Master Agreement in the evolution of the OTC derivatives markets and highlighted the combination of legal techniques behind the various ‘self-help’ remedies in this contract. These contractual remedies, which culminate with Close-out, are designed to manage disruption arising during the lifespan of a derivatives contract without requiring recourse to the formal procedures associated with enforcing rights under general law. While versions of these self-help remedies appear in many types of financial contracts, including in market standard syndicated loan agreements and in the terms and conditions of debt securities, they have reached unmatched levels of sophistication in the derivatives context. As such they have been referred to in a recent English case as amounting to ‘an exclusive code’ under which parties manage the implications of a breach of contract, to the exclusion of the general law. As is now well-documented in the literature addressing the transnational qualities of modern finance, these arrangements underpin the cross-border markets in OTC derivatives by promoting autonomy from national insolvency law, a strategy which has, in turn, enjoyed generous regulatory treatment. The questions to which this chapter now turns is what role is left for the courts in relation to such a tightly designed, closely maintained and ‘exclusive’ contractual framework, and, as a starting point, why such litigation arises in the first place.

Financial markets litigants may, for different reasons, seek to bypass the legal landscape discussed thus far. Where parties have agreed to contracts expressly selecting English law and, in some version of a jurisdiction clause, the English courts, this may give rise to a preliminary dispute about the effects of the parties’ contractual choices. If so, the result is a classic example of what Robert Wai refers to as ‘“touchdown” points’ between a private regime and state law. The concern of the current and the following chapter is how the English courts navigate challenges to the choice of jurisdiction and governing law provided for in derivatives contracts, and the related legal issues that arise as a result of the global reach of the modern OTC markets. The principal focus here is claims arising out of or connected to the parties’ contract; where allegations relate to a broader, fraudulent scheme, the tort of conspiracy or deceit different principles will apply to determine governing law and jurisdiction.

So far, we have seen that derivatives mis-selling cases have three typical features: multiple claims; complex trials; and, as many of the recent cases suggest, unsuccessful outcomes for claimants. The cases show that there are two fundamental reasons why many mis-selling claims based upon contract and tort are unsuccessful. The first is the claimant’s failure to establish all of the necessary elements of the claim, and the second is the defendant’s successful reliance upon contractual disclaimers. The preceding chapter considered the high bars involved in establishing certain types of claims associated with mis-selling litigation. Overall, it argued that it would be exceptional for a claimant to be in a position to establish fraud, while the core claims for mis-representation and breach of duty require claimants to establish certain elements with a high degree of precision and specificity. At the same time, statutory schemes of redress offer piecemeal coverage only, while the courts have been unpersuaded by attempts to construct alternative avenues for redress based upon tort or equity. These factors heighten the relevance of private law claims within the regulatory matrix, and help to explain why mis-selling claims involve such a diverse set of market participants.

Paradigmatic mis-selling claims involving OTC derivatives are based upon contract and tort law. Those types of claims, and the defences routinely deployed against them, are explored in subsequent chapters. We shall see in those chapters, as in later parts of the book, how the specialist mode of contractual interpretation adapted to the derivatives markets is integral to every stage of such claims. In many cases, in fact, it is decisive. However, the paradigmatic claims arising in this part of the financial markets are important not only for their own sake and for commercial law more broadly, but also because of how they relate to the regulatory rules in place to protect participants in the OTC derivatives markets, which is the concern of this chapter. In particular, as this chapter shows, the limitations of the regulatory schemes of redress in this context commensurately increase the significance of the private law claims explored in the remainder of this study.