Strategy & Operations » Legal » SMEs bear the brunt of the toxic forex double whammy

MANY forecasts suggest that the UK’s economic growth is set to accelerate in 2015, with both the European Commission and the British Chambers of Commerce suggesting growth rates of 2.4% and 2.5% respectively, while minister for trade and investment, Lord Livingstone, believes that SMEs have the potential to become the economic powerhouses of the UK economy.

He goes on to suggest that this success will be dependent on expansion beyond domestic markets, and this is all ostensibly good news – far be it for me to put a damper on such positivity – but at a time when the reputation of our best known financial institutions is under threat following their less than squeaky-clean handling of foreign exchange contracts in recent years, one wonders where SMEs are going to find the courage to put their heads above the parapet and explore the opportunities of overseas trading when they are already potentially facing the double whammy fallout from the toxic forex fiasco.

I hope that none of our SME colleagues reading this will take offence when I suggest that theirs is a sector comprised of many small, often (but not always, of course) operators who are not sophisticated financial market players simply trying to make the most of their companies, but it’s true, which is why it’s all the more horrifying that these businesses are unwittingly being sucked into the complicated machinations of the foreign exchange markets – and paying the ultimate price.

At least that’s the feeling we get at Collyer Bristow as we are being approached by more and more companies looking for advice and guidance because they feel that they have been the victims of foreign exchange derivative mis-selling and are now keen to bring claims against the banks that got them into the quagmire in which they find themselves today.

Recent press coverage of the financial regulators’ decision in both the UK and US to impose fines totalling in excess of £2.6bn on six leading global financial institutions for their traders’ manipulation of foreign exchange rates has undermined the public’s trust in our UK financial system and raised questions about its integrity, and businesses caught in the crossfire are looking for redress.

Double whammy

Not only do they feel that they were mis-sold the derivatives in the first place, but also that the subsequent manipulation of the spot rate has acted as a trigger to exacerbate the situation as a “double whammy”. And it’s easy to see why, as this simple example shows:

Company A agrees to buy $1m on 31 December at a rate of $1.60: £1 from a Bank. If the spot rate exceeds $1.65:£1 at any time between now and 31 December, it operated as a trigger and Company A has to purchase $2m instead of $1m and that the $2m will be purchased at a rate of $1.55:£1.

So, if the exchange rate between the US Dollar and Sterling moves to $1.65:£1 before 31 December, Company A will not pay £625,000 for $1m as originally intended, but instead will be forced to pay £1,290,322 for $2m instead. (That’s £645,161 for each $1m).

Once the trigger level is hit, Company A makes a loss of £40,322 – even though the direct impact of a move from $1.65 to $1.651 would only have cost around £367 when buying $1,000,000.

Explained like this, it’s clear that a small change in the spot rate can have massive implications for a business, but the problem has been that the consequences of these complex transactions were not always made clear at the outset. Instead of providing an effective hedging device for business, these contracts speculate on the forex markets – which is exactly what the companies – who trusted their banks to help them – were trying to avoid in the first place.

Combine this with the manipulation of the spot rate and the demon double whammy becomes clear.

And because the manipulation of the forex spot rate will have affected many more customers in this way than those the traders were deliberately targeting, the impact is potentially massive and at Collyer Bristow we are doing our best to find a way through the collateral damage, seeking redress for clients. And from what they tell us, we believe it’s possible that the banks could now be exposed to multiple claims – including breach of confidentiality, unjust enrichment, breach of best execution obligation and rescission (cancellation of the forex purchaser agreement made between the customer and the bank).

The regulators estimate that the manipulation of the foreign exchange market had been going on for several years (between January 2008 and October 2013), with certain forex traders co-ordinating their trades with one another to manipulate benchmark foreign exchange rates. While there are no indications that this practice continues today, complex forex contracts continue to baffle those unfamiliar with the jargon and workings of foreign exchange markets. So if your business is trading overseas – or is looking to do so in the future, as many of you out there will soon be doing, according to the leading business bodies quoted earlier in this article, make sure you understand what you’re getting into before it’s too late.

Robin Henry is a partner with Collyer Bristow’s financial disputes team