Wednesday, March 23, 2011

German High Court Rules that Bank Had Duty to Advise on Risks of Complex Derivatives Contract

The German Federal Court of Justice has ruled that a global German bank violated its advisory duties with regard to a derivatives interest rate swap contract and was liable for damages. A bank must determine investment advice with regard to derivatives contracts before making recommendations, noted the court, taking into account the risk appetite of the investor, unless the bank has had a long business relationship with the investor or already knows the recent investment behavior of the customer. Further, the professional qualifications of a customer cannot in itself allow the bank to conclude or infer that the investor has knowledge of the specific risks of a CMS Spread Ladder swap contract, said the court.

With such a highly complex and risky structured derivatives product such as the CMS Spread Ladder swap contract, there was a high demand on the bank to provide advisory services to the investor. Similarly, the customer needs to be enlightened as to the risk of such highly complex derivatives products with substantially the same information and knowledge as his or her advisory bank because it is only then that a responsible investment decision can be made as to whether he or she will accept the offered interest rate be. Special circumstances existed with the recommendation of the CMS Spread Ladder swap, said court, because the advisory bank knew that the product had been structured to the detriment of the investor.

The Federal Court of Justice is Germany's highest court of general civil and criminal jurisdiction and is the court of last instance in matters of general jurisdiction, with the Federal Constitutional Court hearing only constitutional complaints. The Federal Court of Justice has issued a summary of its opinion, with the full text of the opinion expected in several weeks.

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