Monday, August 6, 2012

The mischievous ways of bankers' dealings

In the "good old days", the management of interbank transactions was quite simple (primarily because the unterlying transactions were quite simple). Here is how it worked in times before internet, email and data banks.

The bulk of interbank business consisted of lending/borrowing money and of buying/selling foreign exchange. The underlying documentation could be simple, for example: "We confirm having borrowed from you..." or "We confirm having sold to you...".

Bank A would, for example, lend 1 million to Bank B for one month. The telephone conversation was the contract. Once the dealers of the two banks had agreed on something, the deal was done. Right after striking the deal, the dealers of both banks would fill out, in handwriting!, a socalled "dealer's slip", summarizing the details of the transaction. That dealer's slip would be passed on to the respective bookkeeping departments which would neatly type up a so-called "confirmation slip". Each bank would put that confirmation slip in the mail to arrive at the counterparty a couple of days later.

Upon receipt of the confirmation slips, the bookkeeping departments of each bank would reconcile them with the open dealer's slips. When matched, as almost always the case, they would be filed away. In case of a mismatch or in case of a missing confirmation slip, follow-up inquiries would be made. If there were differences between the two confirmation slips (i. e. if there was a misunderstanding between the dealers about the deal they had concluded), a solution would have had to be negotiated. In the worst case, it could perhaps be discovered that improprieties were involved.

And how is it today?

Transactions have become enormously more complex (i. e. derivatives). So complex that a short dealer's slip could not summarize them adequately. Thus, for derivatives, the International Swaps and Derivatives Association developed a Master Agreement covering derivatives transactions. One can imagine that enormous legal brainpower was invested in that. Based on this, a dealer's slip could simply refer to that Master Agreement which the deal just concluded was subject to.

All fine and dandy if bankers hadn't gotten smart. This article from the Financial Times suggests that bankers have gotten smart (once again). Bankers would insert "non-standard terms" into the confirmation slips. Since the confirmation slip (and not the Master Agreement!) is the legally binding document for the transaction, a lot of new small print could be inserted into the confirmation slip. Theoretically, that new small print could even eliminate the application of the Master Agreement and the confirmation slip would then become a totally new agreement in and by itself.

I am not suggesting that bankers are willfully taken each other for a ride with legal tricks in new small print in confirmation slips. However, the chances of "accidents" to happen along the way are increased. But, certainly, when the counterparty is not a professional bank but a "real customer" who does not have all these special insights, the question arises to what extent that real customer is in a position to become aware of and/or to judge what the new small print really means. At the latest, he would find out in case the deal goes sour. Certainly at that point, the bank would remind him of all the non-standard clauses in the small print of the confirmation slip which he had signed...


  1. "Theoretically, that new small print could even eliminate the application of the Master Agreement and the confirmation slip would then become a totally new agreement in and by itself"

    Theoretically? I would not put it past a few bankers to sort out a few clauses for their derivatives transactions via the pdf attachment to an email.

    Some sneaky wording would certainly turn some tables. Given the estimated $700trillion derivatives in the USA (some 95% of all known derivatives worldwide) this sort of thing could do some serious damage to countries whose GDP is only $15tn.

    1. Of course, any non-standard clauses are sent separately via enclosed PDF! Not enough room on a confirmation slip for them. How often have you received a standard message from an insurance company or others saying "Enclosed you will find our updated Business Terms and Conditions"? Do you always employ lawers to tell what that they really say? I don't.

      Now, the so-called "professional market participants" can't be fooled so easily. They know the tricks which they apply to others and they can make sure that no tricks are applied to them.

      Take only the ESM. I would have thought that everyone involved would have known what's included in it. Still, it still seems like every other day some journalist comes up with something new in the small print that he has discovered. Did it get into the small print by itself? Of course not! Somebody put it there and whoever put it there knew why he was doing it.

      If derivatives were traded on an official exchange instead of "over-the-counter", things would be different. For some reason, the "professional market participants" object to that. Can you think of any reason why???

  2. I must admit to not employing a lawyer to do that sort of thing, Jasper was pretty good at it though (he is a law lecturer at one of the Amsterdam universities).

    "They know the tricks which they apply to others" - doesn't that say it all? It is more of a cabal than a fraternity.

    Now as to the trading of derivatives on an official exchange, that would rather spoil the fun, wouldn't it?