Pandemic and pandemonium: investors struggle with margin calls

Posted: 10/08/2020

One of the many economic outcomes of the 2008 financial crisis was low interest rates and, consequently, cheap finance. This led some savers and investors to invest or speculate using leveraged products – that is, investors paid only a portion of the investment price themselves with, effectively, the banks or other financial institutions paying the balance.

Leveraged financial products are highly complex and bring mixed blessings for investors. In good times, an investor benefits from the increases in value of the total investment – not just the part they paid for. In bad times, when asset values decrease, an investor either faces margin calls or, if unable or unwilling to raise that margin, the prospect of the bank closing out the investment, either wiping out the investor’s original investment and any previously-posted collateral or, in addition, rendering the investor liable for further resulting losses. The market changes following the Covid-19 pandemic of March 2020 have led to market collapse – generating problems for investors in speculative leveraged products.            

It is too early to tell to what extent, if at all, bad behaviour by banks and other financial institutions has crept into these transactions, as was found to be the case with the 2008 financial crisis – think LIBOR and FX manipulation, mis-selling of various financial products and the huge fines imposed by regulators. Equally, we cannot yet judge whether the consequent raft of regulation imposed on the financial sector, the impetus from within, and the pressure on banks to clean up their acts, have limited the scope for, and impact of, bad behaviour this time around. At this stage, cases have to be considered on a case by case basis unless or until any wider patterns emerge. To date we have considered cases relating to:

• spread betting;
• contracts for difference;
• foreign exchange investment using leverage; and
• leveraged share portfolio investment.

The issues involved have centred around:

• the sale of the product – categorisation of the investor as retail or professional client and suitability of the product for the investor;
• margin calls – calculating the level of margin, timing of calls and procedures followed, the impact of oral representations on contractual terms, contractual interpretation and the exercise of any discretion afforded to the banks; and     
• close out - its timing, the procedures followed, the extent or use of automated processes and contractual interpretation as to pricing on close out.    

In our experience, early and informed discussions between the parties can lead to sensible compromises; it is important for investors to have seasoned litigators who understand the financial products fighting their corner either to obtain that compromise or take or defend their position in any ensuing litigation.

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