Günter Reiner
The Legal Nature of Financial Derivatives
("Derivative Finanzinstrumente im Recht")
Abstract
In his post-doctural thesis Professor Reiner develops the so called
Failure-of-Consideration Approach (“Zweckverfehlungsansatz”,
“causa-Ansatz”) which explains the existing of unenforceable risk
contracts (wager, gambling contracts) on the one hand and enforceable
risk contracts (for instance insurance contracts, most of futures,
forwards, options and swaps) on the other hand. His approach describes
the unenforceable nature of gambling contracts as a consequence of a
failure of consideration.
A
bilaterally binding contract is or at least should be unenforceable for
a lack of consideration, whenever it is sure already at the moment of
its conclusion that one of the parties will fail to achieve the purpose
of its obligation towards the other party. That is the situation of a
wager or gambling contract: One of the parties will necessarily be
frustrated in the end.
In contrast to wager or gambling
contracts, the situation of risk contracts like insurance contracts is
quite different, which is why those contracts are enforceable. The
insured party will achieve its object – getting security - for sure,
regardless whether the insured risk will realize or not and she will
not be frustrated if the insured risk does not occur. Therefore, from
an ex-ante point of view, it is possible that both parties (including
the insurer) derive a benefit from the contract. For the same
reason a financial derivative contract should be legally binding, if and only if the
parties can close their risk position with an offsetting (hedging)
transaction at any time of the contract period (derivatives in the proper
sense of the term). In that case, the contingent obligations of the
contract are continuously valuable (and duplicatable) at market during
the whole contract period. That is why such a derivative contract is a
real exchange contract with a significant consideration just like an
insurance contract and unlike a wager or gaming contract subject to the gaming exception. To meet the
prerequisite of being hegdeable there must be either a liquid market
for the derivative’s underlying or, at least, for the derivative
contract itself.
In
addition, the fact that the contingent
obligations of derivatives (in the proper sense of the term) have
a determinable value in itself at any time during their term
implies some other legal
consequences, especially regarding accounting and insolvency law.
There
are good reasons to consider that, in the case of insolvency
proceedings, ongoing derivative contracts are not ordinary executory
(non-performed) contracts which entitle the insolvency administrator to
opt between closing out or fulfilment of ongoing contracts (i.e. the receiver's right to
request or reject performance). As the risk
position of ongoing derivatives (in the above sense) can be hedged or
replaced (dublicated) by alternative investments of both parties with a
third person at any time, there is no real need for the continuation
option. On the contrary, with regard to general principles of contract
law it would be more coherent to consider an ongoing derivative as
closed out ipso iure at the moment of the institution of the insolvency
proceedings and to settle the derivative on the basis of its current
market value. From this perspective, “Close-out Netting” and “Single
Agreement” provisions in master agreements for financial derivatives
(such as sections 2 and 6 of the 2002 ISDA Master Agreement) can
conflict neither with the insolvency administrator’s right to repudiate
or fulfil nor with the general restrictions on insolvency set-off.
Thus, special netting legislation, entering into force in more and more
countries (https://www.isda.org/2018/06/12/status-of-netting-legislation/)
in order to promote legal security, is fundamentally (but not always in
the detail) compatible with the basic principles of contract and
insolvency law.
The above statements
about the gambling exception and the insolvency law only apply to the extent
that the premise is fulfilled, i.e.
that derivatives in the proper sense are involved: instruments that can be
hedged at any time or, in other words, instruments that have a determinable
value throughout their entire term. Such a value may be empirically
ascertainable (market value) if a liquid secondary market exists for the
instrument. However, it is also sufficient if the value can be calculated
theoretically with corresponding recognised mathematical models on the basis of
the no-arbitrage principle ("fair value"). The theoretical
calculability places certain demands on the underlying instrument. If the
underlying is too special or unique, as is the case with certain exotic
derivatives, a serious valuation may only be possible in terms of a minimum
price or may no longer be possible at all. These circumstances should be taken
into account when granting legal privileges to derivatives under gaming and
insolvency law.
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