By Chris Hamby and cross-posted from Buzzfeed
Financial companies have figured out how to turn a controversial global legal system to their own very profitable advantage. The following is an extract from Part three of a BuzzFeed News investigation — Read the whole series here.
In 2006, near the height of Wall Street’s disastrous speculative frenzy, some of the world’s biggest banks smelled an opportunity.
They saw a way to turn the soaring price of oil into hefty profits. And it involved the tiny island nation of Sri Lanka.
The bankers presented officials who ran the state oil venture there with a way to hedge against further price hikes.
What the banks were selling were derivatives, an often complex and risky type of financial instrument that became associated with the financial crisis. They amounted to a bet on the price of oil, but it was a lopsided bet. The banks — including giants such as Citibank, Deutsche Bank, and Standard Chartered Bank — bore very little risk. The risk for Sri Lanka, if the price of oil fell, was potentially catastrophic.
One Standard Chartered executive found the terms to be so “one sided” that she actually refused to sign off on the transaction, protesting to her colleagues that it could cause “unbearable losses” for the already-struggling oil venture, according to a sworn statement she later gave. But one of her bosses, she said, ridiculed her in a meeting and told her not to stand in the way of several million dollars of profits.
The deal went through, and the other banks struck similar arrangements. Then, instead of rising, the price of oil crashed. The Sri Lankan state company found itself forced to pay the banks millions. Sri Lanka’s Supreme Court ordered a temporary freeze of payments while authorities scrutinized the deals.
Deutsche Bank’s response was swift. It had already made more than $6 million on the deal, but it demanded to be paid more — much more. More than $60 million, which was 24 times more than the bank ever could have lost on the deal.
Deutsche Bank didn’t bother pressing its case in Sri Lankan courts or even in the business-friendly English court where the bank and the state oil company had agreed in their contract to settle disputes. Instead, the bank pursued an audacious strategy. It turned to a powerful worldwide legal system and commandeered it for a novel purpose: helping financiers profit from some of their most controversial and speculative practices.
It was a gamble, but it worked; the tribunal accepted the case. This breakthrough came as a delightful surprise to some lawyers around the world who specialize in this legal system, known as investor-state dispute settlement, or ISDS. They saw in it not just a single judgment, but also a lucrative new horizon for the financial industry…