REPOS & SOFTS
Legal Risk Economically speaking, a repo transaction may (reasonably)
be perceived as a collateralised loan as opposed to a trade in securities. In legal terms, however, it is a sale and repurchase, and the implications of a repo transaction can certainly be significant where any one party defaults. Repos are undertaken on the basis of a title transfer. To ensure
the enforceability of the contract, the Buyer should carry out due diligence to ensure that the Seller has good title to the securities. The obligation of the Buyer to return the relevant securities at maturity also necessitates a term within the MPSA to provide for a right of set-off in the event of an insolvency. Mutual set-off in the event of a counterparty default is, therefore, recommended. Repo participants with multiple transactions with each other may seek to enter into a single MPSA that provides for the close- out netting of obligations under all contracts in the event of a default of either counterparty. Each party should also seek evidence of capacity or authority
to enter into the MPSA. Parties should be aware that a court may re-characterise the repo transaction as a collateralised or unsecured loan if the documents supporting the transactions are not carefully drafted and sufficiently clear.
Stock Risk The stock levels of a soft commodity are likely to fluctuate
during the course of a repo transaction, particularly where a right of drawdown is provided in the MPSA. The Buyer should, therefore, check whether the concept of a floating charge is recognised in the jurisdiction where the commodity is located. Where floating charges are not recognised, alternative forms of security should be considered. Local counsel’s legal opinion needs to confirm whether the concept of a floating charge is recognised in the jurisdiction and, if not, whether a commercial pledge may be granted over the objects, such that the said pledge will remain outstanding even if the pledged object is replaced by another object of the same kind. The legal opinion also might consider what view the local courts are likely to take on this subject. To allow for the right of drawdown, the Collateral Monitoring
dollars. Therefore, a Seller may be conscious of the currency risk that its expenses are in a currency that is strengthening against the US dollar, but whose revenues are denominated in US dollars.
Conclusions It is currently impossible to
establish the identity of those who make large commodity trades on Liffe. The identity of traders is only known by the exchange and brokers. Later this year, Liffe has announced that it will introduce rules in London that will analyse the proportion of soft commodities that is held by banks, index funds, hedge funds and grain traders. It also is considering whether to introduce position or delivery limits in soft commodity markets. Similarly, in June this year, President
Sarkozy indicated a new approach is to be adopted by the G-20 in an effort to reduce rising food commodities prices: (i) boosting production; (ii) increasing transparency in the commodities derivatives markets by standardising contracts; and (iii)
... a new approach is to be adopted by
the G-20 in an effort to reduce rising food commodities prices
Agreement could require the surveillance company to report to the Bank at any time when part of the sugar stock is removed from the storage facility. The Bank also may seek the right to affix a plaque or other marking on the storage facility owned by the Sugar Company, indicating the Bank’s right of ownership of the sugar stored therein, in order to place third parties on notice as to the ownership of the sugar by the Bank. These rights would be documented in the transaction so as to provide comfort to the Bank that it would continue to own the sugar stock stored in the storage facility, notwithstanding that the stock levels of sugar likely will fluctuate during the 30-day term.
FX Risk This risk arises where there is a cross-currency repo, or a loan
collateralised with assets denominated in a foreign currency. Many commodities, such as sugar, are priced globally in US
forcing more deals onto exchanges (as opposed to being bilateral). In the face of this increased regulation, political scrutiny, and movement towards market transparency, only time will tell whether the continued demand and enthusiasm for soft commodities, particularly in the context of repo transactions, will wane as investors grow more informed about the potential of this asset class for entering hedging markets, portfolio diversification and commodity speculation. •
Prajakt Samant & Rashpaul Bahia are partners in the Energy and Commodities Advisory Group of the London Office of
international law firm McDermott Will & Emery.
www.mwe.com
September 2011 91
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