Exchange rate volatility and cost exposure in international arbitration

June 2024  |  SPECIAL REPORT: INTERNATIONAL DISPUTE RESOLUTION

Financier Worldwide Magazine

June 2024 Issue

Parties to an arbitration are often from differing jurisdictions. With that comes a difference in the functional currency those parties might operate in, meaning that one party may be disproportionately exposed to potential risk from exchange rate fluctuations.

Currency considerations in international arbitration cases, where parties are based in differing jurisdictions, will routinely be factored into the quantification of damages. There is, without doubt, a need for experts acting in cross-border disputes to consider sometimes complex issues arising from fluctuating exchange rates when they are opining on quantum.

However, the impact on the arbitration process itself, in particular the impact on associated arbitration, legal and expert costs, is often overlooked. Does this create an unlevel playing field when it comes to accessing and participating in international arbitration as a dispute resolution mechanism?

To consider the implications of exchange rate fluctuations on parties to international arbitration, it is useful to understand the geographical spread of arbitration institutions and the parties using them. The Business Disputes Register’s ‘International Arbitration Statistics Report’ states that over 90 percent of arbitrations are handled by 13 arbitration institutions spread across key global arbitration centres.

In 2022, of the 5757 international arbitration cases, 80 percent were in front of six arbitration institutions. However, by value, four of these centres accounted for 63 percent (US$54bn) of the total claim value of US$86bn. These centres were the International Chamber of Commerce International Court of Arbitration (ICC), the International Centre for Dispute Resolution (ICDR), the London Maritime Arbitrators Association (LMAA) and the London Court of International Arbitration (LCIA). Of these, the ICC, based in Paris, was by far the largest with 42 percent of claims by value.

The ICC and ICDR typically quote their arbitral fees in US dollars (USD), and the LMAA and LCIA quote fees in UK pounds sterling (GBP). Parties using these arbitration institutions, but not from those jurisdictions or with major operations using USD or GBP as a functional currency, will therefore have to make payments for these fees in something other than their functional currency.

In addition to arbitration institution fees themselves, costs incurred by parties in respect of legal fees and expert fees will typically also be in the currency used by the arbitration institute. This can have implications for any party which is not based in, or has major operations in, jurisdictions which routinely use either USD or GBP. This issue can be further exacerbated if the party is located or primarily operates in a jurisdiction where the local currency is volatile or is not readily convertible to USD or GBP.

The ICC’s ‘2020 Dispute Resolution Statistics’ analysis identified that 40 percent of parties were from Europe, 25 percent from the Americas and 25 percent from Asia and the Pacific. The ‘LCIA Annual Casework Report 2022’ stated that 88 percent of parties in LCIA arbitrations came from 90 countries other than the UK.

Between them, Asia, the Middle East and North Africa and Central and South America accounted for nearly half of the parties in LCIA arbitrations. Only 5 percent of LCIA arbitration cases in 2022 involved parties that were all from the UK, meaning that 95 percent had at least one international party and 75 percent involved no UK parties.

Similarly, the International Centre for Settlement of Investment Disputes (ICSID), where fees are quoted in USD, has a current pending caseload predominantly centred around parties based in the Americas (Peru, Mexico, Venezuela, Colombia and Argentina).

While the arbitration process can be faster than litigation, complex international arbitration matters take considerable time to progress to the issue of an award (if any) and subsequently to the enforcement of that award. This is a reflection of the high-value, complex claims seen in international arbitration and notwithstanding the introduction of expedited procedures. Parties not based in the jurisdiction the fees are denominated in will bear the risk (and potential reward) from exchange rate fluctuations over the course of the arbitration process.

Data on the duration of arbitration cases is not readily available, but the LCIA’s ‘Facts and Figures – Costs and Duration: 2013-2016’ stated that all cases in that period had a median duration of 16 months. Looking solely at the larger, more complex cases (those with an amount in dispute exceeding US$100m), the median duration increased to 29 months, nearly two and a half years.

The often high-value, legally and factually complex, investor-state disputes overseen by ICSID can take longer than this to reach settlement. At the extreme, the case of Pey Casado v Chile took over 10 years to conclude.

Over a period of a few years, exchange rates can fluctuate significantly, especially if a country sees significant shocks to its economy, resulting in hyperinflation or currency devaluation. For example, over the three-year period of 1 April 2021 to 31 March 2024, the Argentinian peso depreciated against the USD by 833 percent from 91.91 to 857.48 and the Turkish lira weakened by 312 percent from 8.27 to 34.04.

The significant depreciation of the Argentinian peso and Turkish lira would have resulted in a party based in those countries facing a potentially dramatic increase in costs in local currency terms required to fund the equivalent USD or GBP amounts. Consider an example LCIA arbitration, where the parties are based in the UK and Turkey, commencing proceedings in April 2021 and concluding in March 2024, a not unreasonable timespan for a high-value, complex dispute.

At the outset, both parties estimate that they will incur arbitration costs, legal and expert fees of £3m each. For the UK-based party, this cost estimate is not impacted by exchange rate fluctuations over time. However, for the Turkish party, the initial estimate would equate to some 24.8m Turkish lira at the commencement of the proceedings but rapidly escalates four-fold to 102.1m Turkish lira by March 2024.

Even after making allowance for payment of costs over the three-year period and a gradual change in the exchange rate, the cost burden on the Turkish party is significantly greater as the proceedings unfold. Consequently, planning for such cost increases in countries with fluctuating currencies can be problematic and in extreme cases could impede the arbitration process itself. Parties can, of course, use financial instruments to hedge against currency movements but these come with an associated cost and risk, especially for a party that may be unfamiliar with such financial tools.

Do the expectations of what will happen to exchange rates impact on the arbitration process decisions that parties may make? If the exchange rate is moving unfavourably against a party even just for the impact on costs, it may lead to different outcomes as to whether to settle and for what amount.

Anything that alters the economic decision-making process has altered the prior equilibrium position, something which a party not exposed to exchange rate movements would not have to consider. In summary, exchange rate fluctuations can have a significant impact on not only the quantification of damages but also the costs incurred by parties to the arbitration process. Arbitral institution costs tend to be denominated in a small number of major currencies which may not be the functional currency of one or either party.

The exchange rate risk falls unevenly on the parties where one has a greater exposure and need to exchange its functional currency to the currency of the cost. One of the parties to the arbitration may therefore be more cautious when entering into the arbitration process or subsequently come under financial pressure to seek settlement earlier than it otherwise might.

 

Chris Tune is a director, Harshad Bharakhada is an associate director and Emily Richardson is a manager at Grant Thornton UK LLP. Mr Tune can be contacted on +44 (0)20 7865 2504 or by email: chris.j.tune@uk.gt.com. Mr Bharakhada can be contacted on +44 (0)121 232 361 or by email: harshad.bharakhada@uk.gt.com. Ms Richardson can be contacted on +44 (0)113 200 1513 or by email: emily.r.richardson@uk.gt.com.

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BY

Chris Tune, Harshad Bharakhada and Emily Richardson

Grant Thornton UK LLP

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