Introduction

It is essential in dealing with Offshore Financial Centers to develop a method identifying the various relationships created and the underlying risk associated with each part of a financial transaction. Analysts in the process of evaluating risks often divide them into three basic categories: legal risk, market risk, and credit risk. Political and sovereign risks can contribute to such unexpected results by virtue of Sovereign Immunity concepts, the Act of State Doctrine, and exchange controls.

Credit Risk

Credit risk includes the risk that a counter-party will not perform to contract as a result of unanticipated business or financial circumstances. For purposes of this writing, the counter-parties are those related to the transaction and who experience the credit risk stemming from their performance, financial condition, correspondent banks, and depositories such as clearing systems. These counter-parties and the attendant credit risk involve a range of risks. It can comprise a combination of legal relationships and credit risks. Liquidity risk can also be combined with legal and credit risks, producing a hybrid effect.

The terminology credit risk has its nexus in the risk that a counter-party to a financial transaction will fail to perform in accordance with contractual terms and conditions because of inability occasioned either by an event such as bankruptcy, litigation, or other unforeseen event. Such default would cause the asset holder to suffer a financial loss. In this respect, most defaults involve a debtor who fails to discharge his liabilities owing to insolvency. Additional failures to pay may arise as a result of new laws and regulations or amendments of jurisdiction as well as technical shortcomings resulting in the delay of contractual fulfillment or render it impossible. (1) The essence of this writing is to focus upon the effects sovereign regulation and specifically sovereign decree.

Currency Risk and Euro Denomination

A specific category of credit risk of significance in the use of Offshore Financial Centers is that which is associated with international banking risks as they concern Eurocurrency markets. This facet of risk raises issues involving the effect of international banking regulation and Eurocurrency markets. At the very least, appreciation of this credit risk gives the appearance of prudent judgment and enhances the ability to evaluate the risk an Offshore Financial Center poses. Political and currency stability is at the heart of it; in turn they are naturally interrelated.

A deposit of funds in a bank located outside the country of the currency comprising the deposit is a deposit in the Eurocurrency market. (2) If made in United States dollars, deposits made to a foreign branch or a subsidiary of a United States domestic financial institution do not require reserves to be set aside as would be required in a domestic setting. (3) Additionally, Federal Deposit Insurance normally required by the Federal Reserve is not assessed with respect to Eurocurrency deposits of United States dollars. (4) This involves a most complex issue international banking lawyers often refer to as lender of last resort.

The exemption of regulatory costs greatly improves the competitive position of United States banks in the global financial markets. However, Eurocurrency denominated in United States dollars is what financial lawyers know to be interbank transactions in the Eurocurrency market. These interbank transactions are settled on a net basis each day among participants in the interbank settlement system, the Clearing House Interbank Payments System (CHIPS) in New York. Net payments are made among those participants’ reserve accounts of the Federal Reserve Bank of New York.

Many financiers regard it as axiomatic that United States dollar transactions can only settle in New York. The lender of last resort function that the Federal Reserve carries out is embraced in this understanding. This is precipitated by the fact settlements involve sizeable overdrafts among participants on any given day. (5) This general introduction to Eurocurrency has as its purpose to provide background reflecting the thrust of credit risk to be anticipated in Offshore Financial Center considerations.

The mainstream issue occurring with respect to Eurocurrency has involved a parent home country bank and its foreign branch office. Its issues have perplexed the judiciary in formulating international interpretations and decisions. The Eurocurrency feature of the banking issues has clouded legal analysis. The judiciary has conceded there is something of a different order when asked to interpret treatment of deposits in foreign branches. They have indicated they are troubled with the fact Eurocurrency has no reserve requirement of the Federal Reserve and has no insurance requirement of the Federal Deposit Insurance Corporation. They are troubled with the application of traditional banking laws and concepts that have evolved from banking cases in which institutions are within full federal banking regulations. (6)

What is at issue arises when a foreign branch becomes subject to currency controls imposed upon it by the foreign sovereign in which it is an extension of its home country parent. This imposition does not deal with the Act of State Doctrine and its validity. It deals with the implications upon depositors subject to sovereign executive orders. (7) The most renowned case which raised these concerns involved the Central Bank of the Philippines and an Official Memorandum to Authorized Agent Banks. (8) The Philippines, having succumbed to extravagant external debt and untimely political events, experienced capital flight due to economic instability. The sovereign currency, the Philippine peso, was subject to devaluation despite substantial efforts on the part of the International Monetary Fund and major industrial country members to stabilize it.

Citibank of the United States maintained a branch division of its home country financial institution, parent. The Manila branch became subject to the Memorandum to Authorized Agent Banks from the Central Bank of the Philippines. The memorandum required that no repayment of principal on the foreign obligations was to be made. (9) Wells Fargo, a United States bank, brought suit in New York to demand repayment of principal of deposits that it owned in the Citibank branch of the Philippines. Citibank honored the sovereign central bank order. (10)

Credit risk became a part of defendant Citibank, N. A.’s defense. (11) In this defense, it segregated credit risk and sovereign risk. With respect to credit risk, the risk of failure or lack of liquidity of the branch where the deposit was made required that the entire multinational enterprise stand behind the obligation. However sovereign risk is distinguished whereby the depositor assumes the risk of restraints imposed both by the government where the deposit is placed and by the government of the home office of the bank. (12) The contention is the depositor assumes this sovereign risk and a branch is compelled to honor a central bank directive.

The Plaintiff, Wells Fargo, argued the other demarcation of issues. It asserted the clearance or settlement in New York caused it to be a New York obligation and should be made enforceable in the home country, which was New York. (13) The court made an analysis initially to sort through the problems Eurocurrency presents based upon prescriptive jurisdiction, allowing for what minimum contacts might be required for a United States court to exercise jurisdiction.

A conflict of laws analysis regarding minimum contacts necessary to find prescriptive or legislative jurisdiction was its pivotal focus. At times they recognized Eurocurrency was a currency without a country of issue and without a situs. However, they did acknowledge it had traditional territorial links of prescriptive legislation by virtue of settlement and clearance among participants in the payments system. (14) Jurisdiction was asserted pursuant to diversity of citizenship (15) and federal jurisdiction over suits involving international or foreign banking in which national banks are parties. (16)

Because interbank Eurocurrency deposits are effected without the written contractual documentation which courts are accustomed to as in this case, that is, no choice-of-law and no choice-of-forum clauses, it noted the general rule that a contract between a bank and its customers is governed by the law of the place where the account is kept. (17) The New York Court of Appeals on remand for clarification pointed out the benefits of promoting the expectations of the parties required applying the law of New York. (18)

The essence of the facts is essential to understanding the credit risk exposure. Wells Fargo Asia Limited had made deposits to Citibank N.A.’s Manila branch with two one million dollar time deposits. During the course of the time deposit the Philippines by government decree forbade the repayment of the principal of the time deposit of certain foreign currency obligations without prior approval of the central bank of the Philippines; government decree MAAB – 47. (19)

Citibank asserted that Philippine law governed the deposits and that the decree prohibited them from performing upon Citibank’s demand; the contention that permission from the Central Bank of the Philippines was impossible to obtain. The court asserted initially that it was far from clear as to whether it could be established by proof of custom and usage as an agreed upon though unstated condition making he deposit subject to Philippine sovereign risk, that is the risk that the Philippine government could take an action preventing repayment.

Wells Fargo took the position that Philippine sovereign risk was not at issue because the actions of the sovereign government did not excuse honoring the deposits. They recited authority for the proposition that the situs of a bank deposit is the branch where the deposit is made and that the law of that locality governs depositor rights. (20) The court accepted the premise that Citibank’s receipt of a Eurodollar deposit created a liability of the bank. The asset thereby obtained was either loaned out, deposited with another bank or otherwise invested. It noted that even though Citibank was an international corporation with worldwide assets and liabilities, it maintained separate books for each of its branches. Where assets are carried on the books of a Manila branch, those assets are invested with entities situated in the Philippines and considered local assets, Philippine assets. Oh the other hand assets invested with entities located outside the Philippines or on-Philippine enterprises are called non-Philippine assets. (21)

The import and effect upon the Eurocurrency and its exemption from reserve requirements as to deposit payable was touched upon. Foreign branch deposits that are guaranteed by a promise of payment in the United States are subject to federal reserve requirements, but Regulation D is generally interpreted to exempt Eurodollar deposits. Citibank argued that the regulation demonstrates an understanding in the banking community that such deposits are payable only at the branch where made and subject to the law of the host country. Because the court had accepted the proposition that the deposits were payable only in Manila and subject to Philippine law, the assertion by Citibank was deemed moot. (22) The court concluded that pursuant to Philippine law Citibank’s worldwide assets were available for satisfaction of satisfaction of Well Fargo Asia Ltd. claim and that the decree of the Philippine Central Bank did not prevent transfer of assets from outside the Philippines to Manila to repay the time deposits. (23)

The United States Court of Appeals subsequently reviewed the United States District Court’s decision, remanding it to the court in finding it unclear whether the opinion concluded that the parties had agreed that the deposits were collectible only at Citibank’s Manila branch or whether Philippine law governed. (24)

On remand the United States District Court for New York’s Southern District, the court attempted to clarify its position by applying a uniform rule of New York law. Its basis was that the transactions where denominated in United States dollars and settled through the parties’ New York correspondent banks. It reasoned that Eurodollar transactions denominated in United States dollars customarily clear in New York and thus provided a strong rationale for applying the law of New York. At the heart of reasoning was that it was the courts goal to promote certainty in international financial markets and therefore it made sense to apply New York law uniformly, rather than conditioning a deposit obligation on the vagaries of local law. Further it sought to prevent each player in the Eurodollar market to investigate the law of numerous foreign countries to ascertain which would limit repayment of deposits to the foreign branch’s own assets. (25)

Having concluded that New York law was controlling, it stated that the most recent rendering of opinion by the high court of New York held that the parent bank is ultimately liable for the obligations of the foreign branch. (26) In summary the court concluded that New York law that governed this question holds that Citibank is liable for the debt of its Manila branch and Wells Fargo Asia Ltd. was entitled to look to Citibanks’ worldwide assets for satisfaction of its deposits.

***********

Footnotes

1. The Impact of Financial Innovation on Financial Stability, Chapter 10, Recent Innovations in International Banking, Bank for International Settlements, Prepared by a Study Group Established by the Central Banks of the Group of Ten Countries. (April 1986).

2. Dufey and Giddey, The International Money Market, p. 4 – 9, Prentice – Hall, Inc. (1978).

3. 12 U. S. C. 461 (b) (6) (1982).

4. 12 U. S. C. Section 1813 (1) and (5) (1982).

5. Smedresman and Lowenfeld, Eurodollars, Multinational Banks and National Laws, p. 745, New York University Law Review, Vol. 64, Number 4 (October 1989). See also Points of Defense and Counterclaim, Bank Markazi Iran v. Citibank, N. A. No. 1979-B-5903 (Q. B.)

6. Supra at note 2.

7. Wells Fargo Asia Limited v. Citibank, N. A., 660 F. Supp. 946 (S.D.N.Y. 1987).

8. Central Bank of the Philippines, Memorandum to Authorized Agent Banks No. 47 (Oct. 15, 1983).

9. Id. at note 8.

10. Supra at note 7.

11. Supra at note 7.

12. Supra at note 5, page 767

13. Citibank Pretrial Memorandum, at 7-11, Wells Fargo Asia Ltd. v. Citibank, N.A. 660 F. Supp. 946 (S.D.N.Y.) 1987) (No. 84-0996) There was an additional argument that there had been an assumption of risks by operating within branches rather than being separately incorporated subsidiaries, thereby accepting the risk that there could be liability for the branches international activities

14. Supra at note 5 at pages 745-746. See Libyan Arab foreign Bank v. Bankers Trust Co., 1986 L. Mo. 1567, slip op at 2 (C. A. Dec. 19, 1986).

15. 28 U. S. C. 1332 (1982).

16. 12 U. S. C. Section 632 (1982).

17. See XAG v. A Bank, (1983), 2 ALL E. R. 464 (Q.B.); Also A Dicey & J. Morris, The Conflict of Laws 1292 note 51 (11th ed. 1987).

18. Wells Fargo Asia Ltd. v. Citibank, N. A., 695 F. Supp. 1450 (S. D. N. Y. 1988).

19. Citibank, N.A. Manila Branch obtained partial approval but declined to remit the entire principal contending that it was excused by the decree. Wells Fargo Asia Ltd. v. CITIBANK, N.A. 666 f. Supp. 946 (USDC of N.Y. S.D. 1987 at 947.

20. Dunn v. Bank of Nova Scotia, 374 F. 2d 876 (5th Cir. 1967).

21. Id at 948.

22. Supra note 20 at 950.

23. Supra note 20 at 950.

24. 847 F. 2d 837 (2nd Cir. Ct. of Appeal N.Y.1988).

25. Wells Fargo Asia Ltd. v. CITIBANK, N.A. 695 F. Supp. 1450 USDC of S.D of N. Y. 1988)

26. Perez v. Chase Manhattan National Bank, N.A. 61 N.Y. 2d 460 (1984); also see Vishipco Line v. Chase Manhattan National Bank, N.A. 61 N.Y 2d 460 (2nd Cir. NY 1981). Note: Under Philippine Law, branches of banks are not separate legal entities apart from the bank as an institution. As stated by the Philippine Supreme Court in National City Bank of New York v. Posadas, 60 Phil 630 (1934), (affirmed by the United States Supreme Court in Posadas v. National City Bank of New York (1936) 296 U.S. 497, 56 S. Ct. 349, 80 L.Ed. 351.

In accordance with Circular 230 Disclosure