A costly legal battle between Goldman Sachs and the Libyan sovereign wealth fund could have more permanent repercussions for the global banking industry, experts have told CNBC.
The Libyan Investment Authority has accused Goldman of misleading it and taking advantage of its lack of financial knowledge to make "substantial" profits on a series of derivative trades back in 2008. The bank denies the allegations and a full hearing has been touted to begin in early 2016 after a preliminary hearing was completed earlier in the month.
The LIA claims the disputed derivative trades in early 2008 cost $1 billion, and carried a high degree of risk, but lost a substantial amount of value by the end of the year and expired "worthless" in 2011. Court documents allege that Goldman made profits of $350 million and a witness statement from a lawyer working for the LIA claims that the usual disclaimers - called non-reliance agreements - were sent after the trades were made and were never signed.
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Satyajit Das, an expert on financial derivatives and risk management, told CNBC via telephone that the case has the potential to get "extremely ugly".
"This could be messy for Goldman Sachs and for a whole range of other banks," he said, adding that this would bring up the issue of opaqueness with these sorts of trades.
"It could lead to an investigation into the selling practices at banks and the types of financial products they offer."
Beyond the prospect of an investigation, industry experts are also forecasting further regulation of the complex derivatives market.
Anat Admati, a professor of finance and economics at Stanford Graduate School of Business welcomed any new regulation in this space. Without commenting on this particular case, she said that investments in derivatives can be easily misunderstood by untrained investors.
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"Regulation that reduced this opacity would be desirable by lowering the incidence of mis-selling and of bankers taking advantage of the their clients' lack of understanding," she told CNBC via email.
$710 trillion market
Derivatives have been blamed for accentuating the steep falls seen during the global financial market crash of 2008. They are complex financial products that even Goldman's lawyer admitted to when asking for more time to prepare before the full hearing in 2016.
The Bank of International Settlements has estimated that the total amount of global derivatives contracts had a value of $710 trillion by the end of 2013. Major world banks have already made moves this month to reduce the systemic risk in the financial system by giving up their own rights to terminate derivative contracts with troubled institutions. Democratic Senator Elizabeth Warren has taken a hardline with Wall Street and regulators in the past and is likely to have an interest in this particular case, according to Das, although the senator declined to comment when contacted by CNBC.
Gold Sachs International also declined to comment when contacted by CNBC.
UK vs US
Das - who has been a key witness at court cases not too dissimilar to this one - stated that there is no law against Goldman Sachs making money out of these trades and suggested that it might become apparent that its earnings were perfectly consistent with the risk it took.
He also noted that U.S. regulators have played hardball with some U.K. banks in the recent past. With the case being heard in London, he believes that it could be a chance for U.K. regulators to "even the ledger" with an international branch of a U.S. investment bank.
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"This could be politically very interesting," he said.
Adding to the complications, a witness statement at the summary hearing from another lawyer advising the Libyan fund claimed that the U.S. Securities and Exchange Commission were already investigating the derivative trades. The statement said that the SEC had already collected a substantial amount of documents from Goldman and had discussed the sharing of information with the LIA. The SEC declined to comment on this issue when contacted by CNBC.
Action ahead?
Jeremy Glaros, a former head of equity derivatives structuring at Macquarie Group who now runs a bitcoin trading firm called Coinarch, believes that regulators might actually steer clear of this case.
Unless there is evidence of egregious behavior then regulators will rightly view that sophisticated investors should be responsible for their own trades and should be shopping around aggressively, he said.
"The thing I would most like to see change in the banking industry is a return to salaries and bonuses that truly reflect the contribution of bankers to the world at large. The amounts earned are hugely out of proportion on this metric," he told CNBC via email.
