Requests for arbitration on currency derivatives deals quadrupled in fiscal 2011 as small and midsize companies tried to limit losses due to the soaring value of the yen.
The Japanese Bankers Association’s alternative dispute resolution system, designed to provide quick judgments on disputes between banks and companies, received 749 arbitration requests relating to foreign exchange derivatives trading in the fiscal year ending March 2012, compared with only 172 the previous year.
Many derivatives deals, which are used by businesses to reduce risks resulting from fluctuations in foreign exchange rates, have turned sour for companies because of the historic highs at which the yen is trading.
In a typical derivatives deal, a company will make a contract with a bank to sell or buy foreign currency in the future at a set price.
Between 2004 to 2007, the yen traded at between 110 yen and 120 yen to the dollar, and many small and midsize importers bought derivatives to protect themselves against further depreciation on recommendations from banks.
However, because of the 2008 financial crisis and the European sovereign debt crisis, precisely the opposite happened.
The yen has been trading at between 75 yen and 80 yen to the dollar since last year, and many companies find themselves in contracts that value dollars at substantially above the current exchange rate.
Foreign exchange derivatives contracts can cover periods of up to 10 years, and some businesses are facing very large losses if the yen continues to soar.
The JBA’s arbitration system is being used to spread some of those losses. Banks are shouldering part of the losses of some companies at the insistence of the Financial Services Agency.
Among the cases before the arbitrators are claims that small and midsize companies were forced by banks to buy derivatives products for dollar amounts in excess of what they needed for normal trading, while others say that they could not refuse the banks’ offers of derivatives because they were seeking loans from the banks.
Settlements have been reached in about 70 percent of the cases handled by the arbitrators and, in many of the cases, banks are shouldering 30 to 50 percent of the losses incurred by the companies.
The banks are also extending loans to these companies to help them shoulder their part of the losses, although in some cases the banks are reported to be demanding relatively high interest rates.
According to the FSA, the number of contracts for foreign exchange derivatives trades stood at about 40,000 as of the end of September 2010. About 19,000 small and midsize companies were involved in the contracts.
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