International financial operators, in particular banks, are known for their aversion to risk. Although it is generally recognized that their earnings compensate for the risks they run in each transaction, such operators show great ingenuity in seeking to limit, if not exclude, these risks through the creation of increasingly sophisticated financial instruments, such as swaps and derivatives, and through increasing intricacy in the structuring of their transactions, as illustrated by recent technical developments in project financing and asset securitization.

One of the paradoxes of the environment in which economic players evolve-be they international commercial players or financiers-lies in the fact that their growth, if not their survival, is conditioned by their capacity to take risks. The oldest risks associated with economic activity are now for the most part dealt with at the level of state organization, or by the use of insurance techniques that allow the pooling of risks. However, neither political and economic organizational arrangements nor recourse to insurance can provide an absolutely secure environment, especially in an international context. Risk management requires economic players to analyse and assess the risks they face (likelihood of occurrence, extent of consequences), so as to set up mechanisms allowing them, as far as possible, to be controlled.

Regrettably, however, the work thus undertaken is sometimes incomplete, with operators employing less effort in ensuring that the mechanisms thus set up properly fulfill their role in the event of difficulties than in setting up the mechanisms themselves. To use risk terminology, operators could be accused of not always having assessed the risks associated with inconsistency in the performance, or indeed lack of performance, of the contracts establishing and governing the financial instruments or arrangements they have so meticulously devised and implemented. Swaps, derivatives and complex structures set up for project financing and, in more general terms, structured financing, are indeed chiefly based on contracts. Part of the contents of such contracts may be standardized (e.g. the AFB and ISDA general conditions for swaps), but more frequently the complexity of the structure will necessitate a set of separate contracts, sometimes between different parties in different countries, containing very detailed provisions drafted specifically for each transaction. The documentation itself may be extensive and complex, especially where it is necessary to describe the various monetary flows which, by definition, will involve extremely large amounts, thereby justifying such a wealth of precautions. This documentation may also be drafted in multiple languages and subject to multiple laws.

In a situation of this kind (large amounts at stake, complex agreements and diverse players), international commercial players-unlike international financiers-have long relied on arbitration to resolve the disputes which may arise out of their [Page16:] transactions. Paradoxically, international financiers are still too often prone to ageold reflexes leading them to prefer national courts, even if it means spreading future disputes. Such reflexes have been inherited from the time when banks' involvement was restricted to lending money, and where the sole obligation incumbent on the other party concerned was to refund the amounts loaned. Although this attitude is understandable in domestic commercial banking, in complex or international cases it has the disadvantage of raising problems of pendency, with the attendant risk that proceedings will be slowed down due to a proliferation of lawsuits, and of providing operators with only a partial guarantee of the enforcement of the final decision. Considered in terms of risk, such a situation could cause the entire risk assessment contained in the underlying financial transaction to be called into question and undermine the effectiveness of financial mechanisms to which very detailed attention had nonetheless been given.

We do not intend to consider here the arguments in favour of more extensive recourse to arbitration by financial institutions. These have been adequately dealt with elsewhere, and the various studies published on the subject are entirely up-to-date.1 Nor do we intend to deny recent developments, which have seen financial institutions gradually looking more favourably on arbitration.2 Our intention, after first describing the usefulness, in risk control terms, of a few financial mechanisms, is rather to demonstrate how arbitration, in particular institutional arbitration, can guarantee that each of the mechanisms established will function properly in the event of problems. More specifically, we intend to assess to what extent an agreement to arbitrate, preferably through an institution, can help to control the risks of a given transaction.

Without claiming in any sense to have produced an exhaustive list, we may distinguish two main kinds of risks in an international financial transaction: those connected with the transaction itself (chiefly default in payment) (1), and those linked to the context of the transaction, be it economic, statutory or regulatory (2).

1. Mechanisms aimed at limiting payment default risks and international arbitration

The risk of non-payment is the first risk that comes to mind in conjunction with a financial transaction, and various techniques are employed in order to guard against this risk. Some relate to the structure of the transaction itself, through the control of monetary flows, whilst other more traditional techniques involve the taking of guarantees in favour of financial institutions.

The technique of project financing constitutes one of the most successful examples of controlling monetary flow in a given transaction. The entire structure of the transaction hinges around a project company, whose activities are strictly delimited, and aims to isolate this project company from its external environment, so that all monetary flows generated through the operation of the project are used in the first place to repay the funds loaned to finance the project.

This technique is more often than not coupled with the taking of guarantees, which is the second type of mechanism used to guard against the risks of non-payment and which, within project financing, serves mainly as a barrier against claims by third parties. It would make little sense to sell the assets of the project, even if [Page17:] practicable, since the activity of the project company alone enables repayment of the finance made available.

In both cases, there are new benefits to be had by opting for arbitration, and in particular institutional arbitration, as the means of settling disputes. Much has been written on the question of arbitration and bank guarantees, to which the reader is referred.3 It will be of more interest for present purposes, however, to consider how project financing has developed on the question of the choice of the dispute resolution clause.

Analysis shows that in practice there has been a move towards the adoption of arbitration clauses within project financing. This development is primarily to be observed amongst banks, which nonetheless sometimes still allow the arbitration clause to coexist alongside clauses conferring jurisdiction on national courts, without always appreciating the future problems likely to arise from such coexistence. It is also to be seen in relation to states seeking to attract investments to finance their projects. A prime example of this development is Turkey, which in 1999 amended Article 125 of its Constitution to allow arbitration in concession agreements relating to the performance of a public service. Prior to this, the lack of such a provision was seen as an obstacle to the progress of a large number of projects in Turkey, whereas its adoption will result in an influx of foreign finance into the country.

The reasons for the move towards arbitration are well known: neutrality, relative speed, confidentialiy4 and ease of enforcement of awards. The advantage of being able to foresee the outcome of the dispute is in our view an additional reason, the parties being free to choose the law applicable to the merits of their dispute.5 They are also free to choose the seat of the arbitration, directing their choice towards legal systems which favour arbitration and, when the transaction involves a state or state entity as party, avoiding the courts of that state. Above all, they are free to choose their judges and lay down the framework of their involvement.6 Due to their being chosen by the parties or by experienced institutions, arbitrators are usually considered by those involved as having adequate knowledge of the underlying financial transactions to enable them to render awards which are coherent with the philosophy of such transactions.

Recourse to arbitration is seen, rightly in our opinion, as a way of reducing the judicial risk in complex international transactions. This risk is reduced still further if the parties entrust the organization of the arbitration to an experienced institution, like the ICC International Court of Arbitration7 for example, which will ensure that the proceedings progress smoothly.8 Such a choice will therefore take care of the procedural risk. [Page18:]

Bearing in mind how important risk control is to the success of a project financing transaction, the benefit of choosing arbitration as a means of settling disputes when planning the project is plainly evident.

2. Control of the risks connected with the environment in which the transaction is to take place and international arbitration

International financial transactions may be affected by various types of externally generated risks, these being chiefly associated with developments in the economic situation and with changes in the statutory, regulatory, or even political context in which the transaction is set.

Various instruments have been developed to control these risks. These include first of all financial instruments (swaps, derivatives, which are put to increasingly diverse uses, as illustrated by their use as an instrument to cover credit risk (credit derivatives9), and more recently the use of climatic derivatives10) designed to limit the consequences of changes in economic conditions beyond the control of the parties. Secondly, there are instruments of a more legal nature (such as stabilization clauses), which seek to contain the risks associated with legislative or political developments. In both cases, the success of the instruments depends on their ability to be correctly applied when the time comes.

If we examine first of all the most recently developed instruments, i.e. complex financial products, we can see that they were originally intended to allow operators to protect themselves against certain identified risks, such as those pertaining to interest rates or currency exchange. They may also have other functions, and may even be used for speculative purposes (products with a leverage effect). Some of these financial products belong to organized markets, whilst others are used in over-the-counter transactions, on an ad hoc basis. In all instances, there is a strong tendency towards arbitration.

Arbitration has long been known and used for market transactions by various professional organizations in the United States (NASD or NYSE, most frequently). The American courts have also recognized that disputes relating to securities may be referred to arbitration-since 1974 for international transactions11 and 1987 for domestic transactions.12

The same trend is to be observed in relation to over-the-counter transactions. An English court recently confirmed the validity of an arbitration clause included in a swap contract drawn up according to the ISDA model. The parties to the dispute had concluded a set of currency swap contracts subject to the 1992 ISDA Master Agreement (Multicurrency Cross-Border) and providing for arbitration under the auspices of the LCIA. The English court gave effect to the arbitration clause, pointing out that had it failed to do so, there would be 'a real risk that the development and maintenance of an efficient and productive worldwide market in derivatives and swaps might be undermined'.13 In France, although an arbitration clause cannot be incorporated into a non-international contract unless all the parties are commercial operators, the Lyon Court of Appeal found that an arbitration clause in an agreement relating to transactions on the MATIF between a [Page19:] non-professional operator and a bank were valid, on the ground that, since financial transactions involving derivatives were speculative by nature and repetitive, the parties to such transactions should be likened to traders.14 As regards international contracts, the question is unproblematic, since the Court of Cassation has recognized as valid an arbitration clause contained in a contract where one of the parties was a consumer and the interests of international trade were at issue.15

Over and above the question of the validity of these arbitration clauses, which does not in fact cause any particular problems, at least in an international context, the reasons behind the parties' choice of arbitration should, in our view, be examined. The chief reason seems to be linked to the extremely complex and technical nature of the contracts involved. This causes the parties to opt for arbitration, which notably allows them to choose their own judges and to avoid the uncertainty, or anticipated uncertainty, of an expert appraisal procedure, which would most certainly be ordered in such circumstances in state court proceedings. The parties' desire to control or at least contain the judicial risk is reinforced in this field by the specific nature of the transactions involved, which demands specialized knowledge in the financial field.

There are other considerations that similarly lead the parties to prefer arbitration as a means of ensuring the effectiveness of contractual mechanisms in complex financial transactions. It is a way of providing protection against changes in the legislative circumstances in which they decided to undertake the transaction. The most typical example of this type of mechanism is the stabilization clause, the effect of which is to freeze the content of the applicable law at a given date and to make it impossible to invoke subsequent changes in the law against the other contracting party. Such clauses are frequently used in the oil industry and, more generally, in transactions involving investments which require several years, even decades, of operation under relatively stable conditions before they achieve profitability. The wording of such stabilization clauses may vary, as may the scope of protection which they provide to their beneficiary (some clauses, most frequently the older ones, go as far as to guarantee protection even in the event of a constitutional change in the host country), but their basic principle is to allow their beneficiary to restrict the impact on the expected profitability of the investment of a change in a statute or regulation (which could for example affect the customs or tax system in force at the time the investment is made and on the basis of which the investor has formulated the profitability projections relating to its operation and taken the decision to invest). The mechanism of the stabilization clause thus in fact aims to afford protection against the sovereignty risk resulting from having a state or state entity as a contractual partner.

There is no longer any doubt over the validity of stabilization clauses, which have long been used in international practice and have been the subject of several studies.16 However, the effectiveness of such clauses depends on their beneficiary's ability to secure an appropriate penalty in the event that they are not respected. This explains why arbitration has an advantage over state courts, especially those of the host state. By definition, courts in the host state are bound by such state's conception of public policy. If the legislative changes at issue come within its conception of public policy, then the courts in such state will be bound to apply them, and the stabilization clause may prove ineffective. Arbitrators on the other hand are not bound by the host state's conception of public policy, especially when the law of such state is not applicable to the merits. Even if such law is applicable to the merits, they may rely on arbitral case law confirming that the stabilization clause should apply. 17 The decisive advantage of arbitration in this case results from the fact that the arbitrator is a third party and, by definition, not under [Page20:] the influence of one of the contracting parties. Once again, recourse to arbitration guarantees a certain degree of predictability as far as the outcome of disputes is concerned and consequently better control of the risks of a given transaction.

In our view, the usefulness of arbitration in international financing transactions is now beyond doubt. It is no longer a matter of convincing international financiers to have recourse to arbitration, but of convincing them to make the most appropriate choice amongst the various avenues open to them for securing protection against risks of all kinds incurred in the complex transactions that they set up.

In this respect, it is important to draw the attention of operators to the diversity of arbitration institutions and their specializations, if any, to the importance of choosing the law applicable to the contract in the event of disputes, and to the useful possibility of choosing specialist arbitrators.

In more general terms and on a practical level, the drafting of the arbitration clause, which was formerly often left as a point of detail to the end of a transaction, must be seen as one of the first points to be dealt with when negotiating a contract. This can only enhance control of the various risks, which international financiers are most concerned to anticipate, since it will enable the contractual mechanisms to be fully implemented.

1
See especially Ph. Marini, 'Arbitrage, médiation et marchés financiers' [2000] Revue de jurisprudence commerciale 155; M. Boeglin, 'The Use of Arbitration Clauses in the Field of Banking and Finance' (1998) 15:3 J. Int'l Arb 19; W. W. Park, 'L'arbitrage en matière financière' [1996] Revue de jurisprudence commerciale 41; P. Bernardini, 'The Use of Arbitration in Banking and Financial Transactions' (Paper presented at the IBA 12th SBL Biennial Conference, 1995) International Bar Association; W. W. Park, 'When the Borrower and the Bank are at Odds: The Interaction of Judge and Arbitrator in Cross-Border Finance' (1991) 65 Tulane Law Review 1323.

2
See Ch. Dugué, 'Arbitration of Disputes arising from Derivative Financial Instruments and Transactions' (2000) 10 Rivista dell'Arbitrato 1; N. Horn, 'The Development of Arbitration in International Financial Transactions' (2000) 16 Arbitration International 279.

3
B. Chambreuil, 'Arbitrage international et garanties bancaires' [1991] Rev. arb. 33; B. Hanotiau, 'Arbitration and Bank Guarantees-An Illustration of the Issue of Consent to Arbitration in Multicontract-Multiparty Disputes' (1999) 16:2 J. Int'l Arb. 15; B. Leurent, 'Bank Guarantees and Arbitration' [1990] IBLJ 401; E. Loquin, 'Arbitrage et cautionnement' [1994] Rev. arb. 235.

4
See, e.g., E. Gaillard, 'Le principe de confidentialité de l'arbitrage commercial international' D.1987.Chron.153.

5
The parties are therefore free not to choose a law that might cause them to incur a specific judicial risk, such as that of being ordered to pay punitive damages, for example. The law of New York, in particular, recognizes damages of this kind; see, in a domestic arbitration relating to fraud inflicted upon an investor, the acknowledgement by the US Supreme Court of the possibility for arbitrators to order punitive damages when such law is applicable (Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52 (1995)). This type of decision merely confirms the importance for international financiers to control the judicial risks they may run, by inserting an arbitration clause in their contracts and choosing the applicable law.

6
With respect to international financing transactions, it is not inappropriate to draw operators' attention both to specialized institutions such as ICSID (International Center for the Settlement of Investment Disputes), whose jurisdiction is limited to investment issues, in accordance with the Convention for the Settlement of Disputes relating to Investments between States and Nationals of other States, signed in Washington in 1965, and by which the Center was established, and institutions with general jurisdiction like the ICC International Court of Arbitration. Depending upon the structure of the financing, the operators may have a greater or lesser interest in selecting one or other type of institution. There may in practice be some dispute over the scope of the jurisdiction of the institution in question: for a recent example, see the award on jurisdiction given by the arbitral tribunal set up under the auspices of ICSID in the case Ceskoslovenska Obchodni Banka, A.S. v. The Slovak Republic (1999) 14 ICSID Review 251 (in answer to the question of whether a loan guaranteed by one of the states resulting from the splitting up of the former Czechoslovakia could be described as investment and thus come within the jurisdiction of the arbitral tribunal, the latter ruled that it had jurisdiction); see Emmanuel Gaillard, Report of ICSID arbitral awards ('Chronique des sentences arbitrales') [1999] J.D.I. 273; Philippe Pinsolle, 'The Annulment of ICSID Arbitral Awards' [2000:1] The Journal of World Investment 243 at 255-267.

7
During recent years, the Statistical Report of the ICC International Court of Arbitration has shown increasing optimism relative to ICC arbitration pertaining to finance or insurance. Whereas in previous years, an overall assessment showed finance-related ICC arbitrations to be insufficiently numerous to be identified as a separate category (for the years 1995, 1996, 1997 and 1998, see respectively ICC ICArb. Bull. vol. 7/no. 1 at 7; vol. 8/no. 1 at 9 vol. 9/no. 1 at. 8; vol. 10/no. 1 at 9), for 1999 the ICC International Court of Arbitration Bulletin reports a figure of 3.6% for the finance and insurance sector (see ICC ICArb. Bull. vol. 11/no. 1 at 12).

8
One of the most long-standing reservations to recourse to arbitration was the wish by parties in a dispute to be able to resort to state courts for conservatory measures. It is clear that institutional arbitration gives the parties the possibility of applying to state courts as well as making a request to the arbitrators for conservatory measures. This is for instance provided for in Article 23 of the ICC Rules of Arbitration.

9
See P. Mathieu & P. Herouville, Les dérivés de crédit: Une nouvelle gestion du risque de crédit (Paris: Economica, 1998); A. Hudson, ed., Credit Derivatives: Law, Regulation and Accounting Issues (London: Sweet & Maxwell, 1999); E. Courant, 'Utilisation des produits dérivés de gré à gré par les OPCVM' (July-August 2000) 72 Banque & Droit 16.

10
Climatic derivatives are similar to the derivatives used for interest rates, but their underlying assets are climatic indicators (temperatures, rainfall levels, wind speeds, etc.). They are designed to allow businesses to protect themselves against the consequences of the occurrence of certain climatic risks by transferring such risks to a financial institution. On this matter, see E. Deboaisne, 'Produits dérivés, bon vent!' (September 2000) Banque Magazine 52; A. Caillemer du Ferrage, 'Les dérivés climatiques ou l'alchimie des temps modernes: Comment faire de l'or avec de l'eau' (July-August 2000) Banque & Droit 3.

11
Scherk v. Alberto-Culver Co, 417 U.S. 506 (1974).

12
See Shearson and American Express Inc. v. McMahon, 482 U.S. 220 (1987), recognizing the validity of arbitration clauses for transactions subject to the Securities Exchange Act of 1934; Rodriguez de Quijas v. Shearson/American Express, Inc., 490 U.S. 477 (1989), recognizing the validity of arbitration clauses for transactions subject to the Securities Act of 1933.

13
Bankers Trust Co. et al. v. PT Jakarta International Hotels and Development, 12 March 1999, [1999] All E.R. 314.

14
See Lyon, 31 October 1991, Ollier v. NSM (May 1993) 103 Droit des Sociétés 107.

15
See Cass. civ. 1re, 21 May 1997, Renault v. société V 2000 (Jaguar France) [1997] Rev. arb. 537 (Annot. E. Gaillard).

16
We list but the principal of these, as follows: P. Weil, 'Les clauses de stabilisation ou d'intangibilité insérées dans les accords de développement économique' in Mélanges offerts à Charles Rousseau, La communauté internationale (1974) 301; P. Mayer, 'La neutralisation du pouvoir normatif de l'Etat en matière de contrats d'Etats' [1986] J.D.I. 5; N. David, 'Les clauses de stabilité dans les contrats pétroliers: Questions d'un praticien' [1986] J.D.I. 79; W. Peter, 'Stabilization Clauses in State Contracts' [1998] IBLJ 875; Ch. Leben, 'Retour sur la notion de contrat d'Etat et sur le droit applicable à celui-ci' in Mélanges offerts à Hubert Thierry, L'évolution du droit international (1998) 247.

17
See, e.g., the arbitral awards given in the following cases: AGIP s.p.a. v. Gouvernement de la République populaire du Congo, 30 November 1979, (1982) 71 Rev. cri. dr. internat. privé 92 at § 85 et seq.; Government of the State of Kuwait v. The American Independent Oil Company (AMINOIL), 24 March 1982, (1982) 21 International Legal Materials 976 at § 88 et seq.