The English High Court handed down an important judgement last year relating to its duties when exercising close-out powers granted to it pursuant to a clearing agreement.
The outcome of the case is important to remember as discussions progress in terms of which entities owe what duties in maintaining a “fair and orderly” market, which market participants have the right to set and enforce risk limits and which market participants have a “kill switch”. The exercise of and liability for all of these rights (and obligations) need to be borne in mind as they will need to be reflected in the contractual arrangements to be put in place – in, for example, venues’ rules and in the clearing and execution agreements.
The case related to an options trader which was not a member of the relevant exchange which (a) traded through a clearing member and (b) failed to meet its margin call obligations under its clearing arrangements when certain positions went against it.
The court held that where a broker closes-out and liquidates the positions of a client which is in default (in this case, of its margin maintenance requirements) the broker’s conduct was not subject to: an implied contractual duty of care to perform the close out with reasonable care and skill; or a tortious duty of care brought about by an assumption of responsibility to act with reasonable, care and skill.
The broker was entitled to put its own interests first in determining how to conduct the closing-out provided that it acted in good faith in doing so and was not capricious. The fact that the strategy used by the broker was different to the strategy that either the defaulting client would have used or to the strategy it might have used in hindsight was of no import, provided that the broker acted reasonably. For example, the client had argued that the broker should have closed-out some short positions earlier than it did or that it should not have entered into some combination trades.
This case resolved ambiguity under English law regarding the duties a clearing broker owes its client in closing out its portfolio which existed after a number of recent (Sucden Financial v Fluxo-Cane  2 C.L.C. 216; ED&F Man Commodity Advisers v Fluxo-Cane  EWHC 212 (Comm); and Marex Financial v Fluxo-Cane  EWHC 2690 (Comm)). The court applied the ruling in Socimer International Bank v Standard Bank London  EWCA Civ 116 which applied in the context of a fund close-out to a default under a broking contract.
A number of commentators have pointed out that the outcome of the case relied on a number of specific facts and circumstances (including that the court was prepared to favour one party’s expert evidence over another’s and that the broker in question was execution-only rather than an “expert” in options trading), so that it is possible that another court would be prepared to take the view that what was “reasonable” and “non-capricious” so far as this particular broker is concerned would not be “reasonable” or “non-capricious” so far as other brokers would be concerned.
Of course, the way of dealing with law not implying a duty on a counterparty to a contract is to include the duty expressly. However, whether clearing brokers will (or should be) be prepared to accept this is another issue. However, the enter industry may need to consider the participant contracts in light of upcoming regulations.
Since the case was determined, the options trader has made an application for the broker’s costs for which it is liable should be reduced because the broker refused to mediate. The court rejected the application in forceful terms, identifying certain offers made by the broker during the course of litigation (such as to bear its own costs if the suit was withdrawn and the “cherry-picking” of closing-out trades which went against the trader and ignoring trades which went in its favour) and awarded costs against the trader on an indemnity basis.
Sam Tyfield is a Partner at Vedder Price and a member of the firm’s Investment Services, Finance and Transitions groups.