Your Contract or Mine?

A paper out of Oxford and Stanford gives the pros and cons of London vs. offshore, and standard vs. custom when it comes to contracts.  

(November 30, 2012) — Low transaction cost; custom terms; the backing of a strong legal system. 

Pick two. 

Contracts are all about tradeoffs, but according to two top researchers, investors all-too-often slip into default mode for this critical stage of deal making. 

But just how exactly does one decide between basing a contract in London, or a low-regulation offshore haven like the Cayman Islands? And when are the hefty legal fees of a custom job worth the tailored terms? 

Ashby Monk and Gordon Clark, visiting finance/geography researchers at Oxford and Stanford, respectively, endeavored to break down the characteristics of asset management contracts in the global marketplace. Their paper, “The Geography of Contract in the Global Financial Services Industry,” published November 21, takes up two staples of asset management arrangements: London-based contracts and the standard Investment Management Agreement (IMA) template. 

The former, Monk and Clark argue, has earned its popularity. 

“By our account, London thrives because of the density of market intermediaries found in the city (compared to the major financial centers of continental Europe) and the fact that these services are available in a jurisdiction that offers accepted terms and conditions underpinned” by a supportive judicial system. 

European financial institutions may be under “an unwelcome shadow” from the UK hub, but the authors say they nevertheless rely on the experience and expertise found in London. According to Ashby and Clark, this reliance is further reinforced by low transaction costs. 

“London provides off-the-shelf standardized contracts for most financial services,” according to the paper, such as the IMA for asset management arrangements. These standardized forms come with pre-approval by industry associations and professional bodies, guidance from contract specialists, and the tacit blessing of regulatory bodies. 

But this is where the tradeoffs—and second staple of institutional contracts—come in. 

The standard IMA is a means of economizing on transactions costs. According to Clark and Ashby, however, service providers often rely on the IMA’s familiarity and broad acceptance to gloss over the fact that it can become “a mechanism for holding clients hostage who have neither the resources nor the sophistication to rewrite contracts in their own interests.” 

Still, few asset owners have the resources to commission bespoke contracts for every negotiation, or the desire to spend those resources on legal fees. Clark and Ashby propose wresting control of contract design from service providers, in favor of common contracts specific to categories of financial institutions and products.