The Court of Appeal has held that 'market practice' is too wide a term to be implied into an International Swaps and Derivatives Association (ISDA) master agreement covering currency trading transactions by dismissing a claim arising from the 'de-pegging' of the Swiss franc from the euro.(1)
In 2011 the Swiss National Bank declared a floor on the euro/Swiss franc exchange rate at Sfr1.2, thereafter intervening in the market to buy unlimited amounts of euros at that rate to maintain that floor.
15 January 2015 At 9:30am Central European Time (CET) the floor was unexpectedly removed, which led to the immediate and massive strengthening of the Swiss franc against the euro, causing severe fluctuations in the foreign exchange (FX) market for approximately 40 minutes. At 9:47am CET, CFH Clearing Limited, through its automated clearing system, placed a total of 348 orders to liquidity providers in the FX market, including 27 electronic market orders with Merrill Lynch International (MLI) to trade a total of €20,479,000 for Swiss francs at the next available price. MLI's automated system filled the orders almost instantaneously at an extremely low average rate of Sfr0.1821969 and executed the trades. On the main platform for euro/Swiss franc trading, the official low was declared at Sfr0.85. Later that day, Barclays, UBS and JP Morgan, the other liquidity providers that CFH had placed orders with during the period of volatility, each confirmed that any trade executed with CFH below Sfr0.85 would be rebooked at that rate to reflect the official low. However, MLI did not agree to adjust the rate for the 27 transactions to Sfr0.85.
16 January 2015 MLI offered to change the rate to Sfr0.75 after first making a margin call based on the average rate of Sfr0.1821969. Then, it notified CFH that it was terminating their prime brokerage relationship, with the effect that CFH had to agree a final settlement with MLI so that it could transfer its remaining balance to another prime broker.
19 January 2015 CFH reluctantly accepted the adjustment of the rate for the 27 transactions to Sfr0.75.
19 September 2018 CFH issued a claim against MLI, contending that the effect of Clause 7 of MLI's terms and conditions of business was to import into the transactions a contractual obligation to comply with market practice, so as to require it to reprice the 27 transactions at Sfr0.85, the official low of the market range, or cancel them.
The disputed transactions were concluded based on a 2002 ISDA master agreement and schedule between CFH and MLI dated 27 June 2013, supplemented by MLI's terms and conditions of business. Clause 7 of these terms stated that "all transactions are subject to all applicable laws, rules, regulations… and, where relevant, the market practice of any exchange, market… including the FSA Rules".
CFH argued that Clause 7 amounted to an express contractual term that the parties would act in accordance with market practice. Justice Moulder rejected CFH's interpretation of Clause 7 and held that as a matter of construction, it did not impose a contractual obligation to act in accordance with market practice but intended to relieve a party of contractual obligations where it could not perform those obligations because of relevant market practice (a workable construction). In reaching this conclusion, Moulder considered that if the words "subject to" in Clause 7 had the effect of incorporating all applicable laws, rules, regulations and market practices into the contract between CFH and MLI, as CFH contended, this would result in an unworkably uncertain contract. As such, Moulder found that CFH had no real prospect of success on the issue and dismissed its claim.
CFH appealed Moulder's decision, principally based on what it submitted to be the true construction of Clause 7. CFH submitted that Clause 7 was an express recognition that there might be a conflict between the terms of the transactions between MLI and CFH on the one hand and market practice on the other. In that context, the clear intention of the phrase "subject to" in Clause 7 was that market practice would be binding. Therefore, CFH submitted that market practice was incorporated into the transactions and was not merely a "get out clause".
The Court of Appeal dismissed CFH's appeal. The starting point for the contractual analysis was that the parties had agreed that their FX transactions would be governed by a standard ISDA 2002 master agreement and a specifically negotiated schedule, which permitted them to provide for market disruption. The contractual documentation extended to 42 pages of detailed provisions, including in relation to illegality and force majeure events. This documentation did not incorporate market practice and the parties did not adopt any of the options for dealing with market disruption, despite incorporating the 1998 FX and Currency Option Definitions.
Lord Justice Phillips held that there was no arguable basis for finding that the parties had agreed to incorporate market practice generally, given that this was not reflected in the ISDA master agreement. MLI's terms and conditions of business stated at the outset that their application was "subject to… documentation relating to a specific transaction or transaction", meaning that notwithstanding anything in these terms, the 27 transactions remained governed by the terms of the ISDA master agreement. MLI's terms and conditions of business would apply to the broader aspects of the relationship with CFH and to any transactions which were not covered by the terms of the transaction-specific documentation. Therefore, CFH's contention that market practice was incorporated into the 27 transactions, overriding the express pricing and settlement provisions of the ISDA master agreement, failed due to the express scope of MLI's terms and conditions of business, as set out in their preamble.
The Court of Appeal agreed with Moulder that Clause 7 could not be read as incorporating market practice into the transactions between CFH and MLI, and that the alleged market practice was too vague and uncertain to be incorporated as a contractual term. Accordingly, CFH's appeal was dismissed.
The desire to maintain the certainty and stability of the relationship between those contracting based on the ISDA master agreement underpinned the Court of Appeal's decision in this case. This explains the court's unwillingness to find that a party to such a contract should be required to act in accordance with a concept as potentially broad and uncertain as market practice.
Endnotes
(1) CFH Clearing Limited v Merrill Lynch International [2020] EWCA Civ 1064.
