Brace yourself for some temerity, because I'm about to scratch my head in puzzlement and call into question the statements of a Nobel laureate in economics. The
Joong-Ang Ilbo reported on Friday that
Robert Engle, co-winner of the 1993 Nobel, was in Seoul last week to testify on behalf of Dorco, a Korean manufacturing firm that got burned in last year's KIKO debacle. In his testimony, Engle claimed that - and you'll want to brace yourself for this stunner - the banks selling these currency contracts were seeking to maximize their profits. Commence peeling yourself off the floor.
KIKO options allow businesses to sell dollars at a fixed won/dollar rate if the exchange rate stays within the range fixed in the contract. If it soars above the upper limit, however, exporters can sustain huge losses, as they have to pay more for dollars on the currency market to sell them at the fixed rate to the banks. With the won plunging against the dollar in recent months, many local businesses suffered massive losses and are now on the brink of bankruptcy.
The Seoul Central District Court then stepped in last December and ruled
that the KIKO contracts between SC First Bank and two Korean exporters were invalid, saying that the bank did not adequately inform the companies of the risk involved in the contracts, a ruling which opened the door for further lawsuits. Yet, as I wrote in January, ignorance should not be a valid defense for the companies that purchased these contracts.
And despite Mr. Engle's testimony, I stand by that opinion to this day. One of the greatest moral traits of free markets is that they rely on voluntary cooperation, which means that if a deal doesn't suit you, you can walk away from it. This, however, requires discretion on both sides, that is, the proper consideration of risk and opportunity. If you feel you don't have enough information about a product or service to make an informed decision, then walk away. You are allowed to do so.
To be fair, the Joong Ang article does not quote Engle as saying that firms should be protected from the consequences of their mistakes. Rather, according to the article, he asserts that "the knock-in knock-out contract, also known as KIKO, was designed so that banks would benefit far more than the small businesses that bought the risk-hedge derivative products." No doubt many will jump up, waving their arms in indignation at the notion that both sides did not reap precisely the same profit, but there is no particular reason why this should be so.
Sean Hayes, writer of the
Korea Law Blog and a consultant to the law firm representing 50 of the KIKO plaintiffs, however, sees it differently:
In some cases...clients were asked to sign English-language contracts, despite being unable to speak English. He recalls sitting down with one plaintiff: "He pointed at a word and asked what it meant. The word was 'buyer'. He didn't even know what 'buyer' meant."
In other cases, no contract was sent - the only documentation the client received was the trade confirmation. Some companies apparently felt that getting loans in the future was conditional on buying the kiko. Others were rushed into the decision on the basis of a quick, five-minute sales pitch. Most of the companies were too small to have a derivatives governance structure - typically, the authority to go ahead with the trade rested with one person, who was the business owner or the person looking after the company's finances, he says.
All of which merely seeks to excuse ignorance and rationalize a bad decision. But it's a bad decision that's already been made and the courts seem willing to protect the companies from the consequences, so all we can do here is try to draw a few lessons for the future. Here they are: First, if you don't speak English, then don't sign a contract written in English. Second, if you don't have a staff capable of handling these sorts of financial matters, be aware of your own limitations and think twice about signing something you don't understand, no matter how pretty and promising it might appear at first glance. And finally, banks are not obligated to loan their money to your company.* If they want to make your future loan availability conditional on present KIKO purchases, they can probably do so. If they want you to do naked cartwheels down the middle of Main Street in exchange for future loans, they can probably do that, too. It's their money, you're asking to use it, and, as such, you'll have to meet their conditions. You don't like the conditions? Go elsewhere, or use your own money.
In order for markets - indeed, for society - to function, courts must enforce the terms of contracts as written, not the terms as an embittered party wishes they had been written. Unfortunately, the initial district court ruling last year set a terrible precedent and opened the door for other companies seeking to wiggle out from under the fallout of their own blunders. Accusing banks of reaping "excessive" profits may succeed in distracting attention from this reality, but it doesn't change it.
