The derivatives genie is now well out of the bottle, and these instruments will almost certainly multiply in variety and number until some event makes their toxicity clear. Central banks and governments have so far found no effective way to control, or even monitor, the risks posed by these contracts. In my view, derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal. –Warren Buffet 2002
“It’s an established fact: corporate governance in Brazil is divided into two periods: before the derivatives scandal and after it.” –Rodrigo Zeidan, Fundação Dom Cabral.
According to research performed for the Folha de S. Paulo — and not, for some reason, by the FSP — courts are tending to uphold the caveat emptor school of thought on the subject of
I translate. Author: Adriana Aguia, Valor Econômico | Portal ClippingMP.
The exchange-rate derivative contracts that pressured the finances of such major business groups as Sadia, Aracruz e Votorantim, causing billions of dollars in damage during the panic of 2008, are now being recognized as valid by the Brazilian judiciary.
During the 15 minutes of fame generated by the Aracruz and Votorantim “too big to fail” derivatives cases, Brazil’s SEC, the CVM created and issued a new accounting form — above — in which derivatives contracts would be reflected on an appendix to the quarterly books.
In 2010, CVM issued Instruction 486/10,
which deals with the execution and clearing of derivatives contracts negotiated or registered in organized trading venues: the stock market, the commodity and futures market, and the organized OTC. The main objective of Instruction 486/10 is to support information-sharing on derivative transactions conducted in the market or in an OTC by the oversight bodies of the stock, commodities and futures exchanges, in keeping with certain recent and unprecedented tendencies in the Brazilian market.
The roots of the current crisis are found in the most part in the non-regulated markets and in investment products traded in certain countries. On that basis, the CVM conducted a broad debate with various international bodies on the best way to regulate and oversee such markets. One issue that many parties say needs attention is over-the-counter derivatives, which are negotiated and liquidated directly between the parties.
In keeping with these initiatives, and bearing in mind that Brazil’s regulatory environment already possesses many of the internationally-recommended features, Instruction 486/10 clears the way for a series of new regulatory measures to increase the transparency of the OTC market, contributing to a more effective environment of risk assessment by the parties and to more effective oversight by regulators.
In the meantime,
Companies are questioning the validity of these contracts in lower courts as well as courts of appeal. In their rulings, a number of judges have found that the companies knowingly assumed the predictable risks of this type of transaction and are ordering that the banks be repaid.
A survey conducted for Valor by the law firm of Wald Associados turned up at least 27 pending law suits on this topic. In practically all of these cases, financial institutions have won the day. Thirteen of these suits have been fowarded to the state high courts, with the same result. Cases included that of soy processor Imcopa, steel mill Tuper, poultry producer Doux Frangosul, and home improvement and furnishing retailer Tok & Stok.
Wald: Judges have ruled on technical grounds, recognizing the peculiar nature of derivatives contracts.
The judiciary has been implacable in its insistence on the validity of derivatives contracts tied to the real-dollar exchange rate, signed by banks and companies in the early days of the 2008 world crisis.
A summary produced by Wald Associados of 27 major cases of this kind shows that the state high courts of S. Paulo, Santa Catarina, Paraná and Rio Grande do Sul all voted in favor of holding companies to these contracts and allowing financial institutions to commence collections proceedings.
The situation in the lower courts is comparable: few judges have ruled in favor of rescinding these contracts. In light of this scenario, many companies have preferred negotiating with banks over the renewal of the relationship.
One company defeated in court was Imcopa, the largest producer of non-transgenic soy in Brazil. Initially, the company managed to obtain a ruling favorable to rescinding a contract, but the state high court of Paraná (TJ-PR) voted unanimously to overturn this ruling and ordered Imcopa to pay WestLB Bank BRL 1.5 million.
Tuper, a major steel processor, questioned certain aspects of the contracts as negociated. It claimed to have paid R$ 4.3 million to Banco Itaú and no longer owes it anything, as subsequent contracts cannot be considered valid. A São Paulo court upheld the lower court judge’s decision, ordering the payment of an additional R$3.4 million In the wake of this decision, the company preferred to renegotiate the contract.
Other firms await judicial decisions as well. Poultry producer Doux Frangosul, recently acquired by JBS, appealed to the state high court of S. Paulo after being ordered by a lower court to pay R$ 30.5 million to Banco UBS Pactual.
Home improvement and decoration chain Tok & Stok, which also moved to rescindo its contract, not only lost its motion but was also ordred to play R$ 17 million in losses from derivative contracts signed in August 2011. This order, however, was itself later overturned.
With the world financial crisis of 2008 and the rise of the dollar against the Brazilian real in September of that year, many companies went to court to rescind rates swaps contracts, under the terms of which the paper would appreciate so long as the dollar remained below an agreed-upon ceiling and depreciate if it did not,
These plaintiffs now claim the contacts were inherently unfair. The banks had their losses limited, but derivatives signers had no such protection. Other plaintiffs make use of an argument known as the “theory of foresight.” According to this view, the growing strength of the dollar, from R$ 1.55 to R$ 2.40 per dollar, was an unforeseeable event that created an imbalance and therefore should have led to a review and revision of the contract.
Finally, there are lawsuits underway in which plaintiffs claim that banks offered derivatives contracts to unqualified clients without explaining the risks involved. If true, this might open the way to rescinding the conducts for bad faith and breach of trust.
These arguments have by and large been rejected by the courts, however. The judge in charge of the Imcopa case, Hayton Lee Swain Filho, took into consideration the nature of the business, “which by its very nature involves the risk of changing interest rates.” Swain said that “no judge should consider these losses as so unforseeable and exceptional as to grant [plaintiffs] an unjustifiable advantage.
Judge Mariella Ferraz de Arruda Nogueira, the São Paulo civil court judge who ruled against Tok & Stok, believed that the risk was adequately stressed by the bank in the case. “The very least that one can expect from a well-known and experienced market player is that it should gather its own information and information about the banking institution with respect to the downsides and upsides of the deal.”
Tok&Stok attorney Antonio Lopes Muniz says, however, that the case was appealed to the TJ-SP because evidence produced was ignored by the lower court judge, violating its right to mount a complete defense. The TJ-SP returned the case to the lower court. In the view of Muniz, the case is nothing like the speculative use of swaps, in which companies use their own assets to bet on interest swaps. Tok & Stok is not in the habit of speculation and only entered into this contract on account of a loan,” the attorney says.
According to our researchers from Wald Associados, these decisions suggest that jurisprudence favorable to the banks is developing.
In the view of Wald, the courts have opted for technical decisions that take into account the peculiar nature of these contracts.”Winning and losing are inherent risks and rewards of these transactions. If you assume the risk, you have to be able to carry it, no matter how considerable the damage,” Wald says.
According to Wald, the principle of equality does not apply to derivatives. “These derivatives constitute a specific bet,” he says. According to Wald, companies have their own information about the risks of doing business, for which reason the courts have to standing to apply the theory of unforeseeability.
In 2008 Brazil, with the outpouring of lawsuits, derivatives volume was reduced to practically zero. “They began to return in force in 2010, however, and are now a routine part of trading,” said CorreiaPorém, voltaram com força em 2010 e viraram uma rotina”, afirma.
Attorney Maurício Almeida Prado, partner in the lawfirm of L.O.Baptista-SVMFA Advogados and an expert on the subject, says that Brazilian law is in line with jurisprudence of most European countries and does not recognize the validity of the “unforeseeable risk.” “These are risk swaps. It’s like playing roulette in a casino and then complaining that you lost,” he says. o mesmo que jogar em um cassino e depois reclamar pelo que se perdeu”, diz.
For many years, Almeida Prado says, companies make lots of money on these contracts. He himself recommended clients holding derivatives to negotiate directly with banks. “Technically, it would be difficult to win a case like this in court.”
Contacted by Valor, the public relations department of JBS and the board of Imcopa had not responded by the deadline for this edition.. Tuper said it would not comment on the situation.
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