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FINANCIAL RISK MANAGEMENT

Ensuring that contracts specify that legal jurisdiction resides with court
systems that have experience in dealing with the particular issues involved and have previously demonstrated fairness in dealing with such
cases.

A thorough review of contract terms may require lawyers with specialized legal knowledge of particular subject areas of law and legal jurisdiction (such as laws of particular countries, states, and districts), including
knowledge of how courts and juries in a jurisdiction tend to interpret the
law as well as applicable precedents. This often requires that legal work be
contracted to outside counsel who specialize in certain areas and jurisdictions. However, care must be exercised to prevent frontoffice areas, which
have a vested interest in seeing that a transaction gets done, from using this
process to shop for a legal opinion, hiring a legal firm that can be counted
on to provide a favorable opinion. The process of outside contracting of legal opinions must be controlled by an inhouse legal department or a single
trusted outside legal firm that can be counted on to offer independent judgments in the interest of the trading firm when this conflicts with the interest
of individual frontoffice areas within the firm.
Adequate and clear legal language may prove useless if sufficient documentation has not been obtained showing customer agreement to the language. The most important measure in this regard is a strong commitment
to following up verbal trade agreements with welldocumented confirmations and signed legal agreements. This requires adequate documentation
staff within trade support functions and the discipline to turn down potentially profitable business from counterparties that do not follow through on
the required documentation. The enforcement of these rules is often placed
within the credit risk function. Documentation should include written confirmation that a counterpartys board of directors and senior management
have knowledge of the activities being contracted and have authorized the
officers of the counterparty firm with which the trading firm is dealing to
enter into such contracts on behalf of the counterparty firm. It is also useful to record all conversations between the counterparties and trading firm
personnel so that disputes as to what terms were verbally agreed to can be
settled equitably, without resorting to costly legal proceedings.
Firms have started to worry about what may be termed legalbasis risk.
This arises when a firm treats transactions with two different customers as
offsetting and hence without market risk (although not without credit risk).
However, it may turn out that slightly different wording in the two contracts
means that they are not truly offsetting in all circumstances. Although carefully vetting contractual language is a necessary countermeasure, an even
better preventative is to use standardized contractual language as much as