Derivatives losses: Tables are turning

The scales are slowly tilting in favour of exporters in their fight with banks on foreign exchange derivatives losses, which triggered a number of court cases in 2008.

If banks had an upper hand initially and forced many exporters to bear the losses, today many of them were willing to bear a bulk of the losses, said sources in the exporter community.

Axis Bank, for instance, recently settled a contract with Nahar Industrial Enterprises at 30 per cent, meaning the bank agreed to bear 70 per cent of the losses. In 2009, YES Bank settled a contract with Sundaram Brake Linings in which it agreed to absorb 60 per cent of the losses.

Axis Bank did not respond to an email from Business Standard. Nahar officials confirmed the settlement, without disclosing details. YES Bank said the figures were incorrect but did not deny the settlement.

Sundaram Brake Linings, in its results for the year ended March 2009, said it had settled the contracts with all banks. In two years, it paid Rs 9.48 crore (Rs 94.8 million) to settle the total loss of Rs 109.48 crore (Rs 1.09 billion) it ran up on these contracts. If one goes by these figures, it seems the company had to bear only a tenth of the losses.

This is a big change from 2008, when a few judgements went in favour of banks and companies like Sundaram Multi-Pap or Nitin Spinners had to bear all the losses. So, what has changed?

Orissa HC stepped

For one, there was an Orissa High Court order on December 24, 2009, wherein it directed a Central Bureau of Investigation probe on a public interest suit blaming banks for these losses.

More than this order, there was a sequel - the two reports sought by the court from the Reserve Bank of India and CBI which confirmed many of the violations the exporters were claiming.

"With this, the civil cases have become stronger. We don't have to argue the extremely complex cases afresh before district courts to convince the judiciary about violations. Wwe can furnish the two reports, which confirm our allegations," said S Dhananjayan of Tirupur's Forex Derivatives Consumer Forum.

The HC had asked CBI to probe alleged mis-selling of these products, violation of foreign currency laws and any "offences of cheating, criminal conspiracy and fraud".

"If the allegations are found to be true, CBI would be busting a large financial scam affecting the economy of the country," the court had observed. But, on February 19, banks got an interim stay from the Supreme Court on the HC order.

Earlier, in a report to the high court, CBI gathered data from RBI that 11 banks had unrealised dues from customers to the tune of Rs 755.45 crore (Rs 7.55 billion) between April 2007 and December 2008, while the gross mark to market losses (by writing down the value of assets to their current value) for customers of 22 banks were Rs 31,719 crore (Rs 317.19 billion) between 2006 and 2008.

Banks had sold exotic derivatives to exporters, who suffered huge losses when their calls on currencies went wrong. In 2007, such bets had backfired when the swiss franc and the yen rose dramatically against the dollar.

After Orissa, more settlements are happening. "We would keep crying foul about banks and few would take note. But, when everything we have been saying is confirmed by RBI and CBI, we stand vindicated," said Dhananjayan, a chartered accountant whose business is at stake, as many Tirupur's exporters facing closure are his clients.

Bankers' imperative

On the other side, banks are also under pressure to clean up their balance sheets and provide for the losses on forex derivatives. "Besides, they realise there's little chance of them winning the civil cases," said Dhananjayan. No wonder, banks are increasingly pushing for out-of court settlements (see table). They have already settled many high-profile cases.

Some exporters in Tirupur, who paid a substantial amount to settle the contracts, sense an opportunity. "They realise that it was not worth paying and are trying to recover their money by filing recovery suits," said an exporter. Besides the Orissa HC ordering a CBI probe, another milestone in exporters' battle was the Supreme Court judgement on June 29, 2009, in the case titled Nahar Industrial Enterprises vs HSBC Bank.

The court said the challenges go into the very legality of the contract, and hence, these cases have to be tried in the civil courts, and not in debt recovery tribunals. What this means is that all forex derivative cases will have to be tried in civil courts and not DRTs. "These tribunals (DRTs) are mainly recovery agents of banks; there's very little scope of getting a fair trial," said an exporter.

In fact, cases (on forex derivatives) in various courts have never been argued, except in Rajshree Sugars. In every case, banks take up the jurisdiction point. They have been arguing that every dispute should go to the Mumbai DRT, given the Isda Agreement and the terms of the contract. Isda, the International Swaps Dealer Association, represents participants in the derivatives industry.

However, the Nahar judgement ensured banks could no longer seek to transfer suits to the Mumbai DRT; this was quashed by the SC judgement. "The DRT mechanism is very simple. Banks would take a recovery certificate from the tribunal and recover the money/assets, just like they would recover other loans," said an exporter. It also meant this fast-track mechanism was closed for banks and they had go through a real probe in civil courts.

Exporters grab advantage

And so, banks have been pushing for out-of-court settlements, while exporters have been keen to pursue cases in civil courts. This could simply be a pressure tactic to force banks to settle the contracts on favourable terms to exporters. For now, the strategy seems to be working.

But, exporters are equally to blame. They all made money on these contracts the year before losses threatened to edge them out of business.

They don't deny this. What they contend is that the losses were highly disproportionate to the profits they made.

For instance, as cited in the Orissa HC judgement, a company which made a profit of Rs 400,000 on a contract the previous year made a loss of Rs 2.39 crore (Rs 24 million) on the same contract in 2008.

"These were highly one-sided contracts. Banks have speculated on behalf of exporters. When losses came, they were booked on exporters," said Dhananjayan.