The 'hedging or speculation' question in determining the capacity of public bodies to trade derivative transactions

First, the article discusses how English courts assess the capacity of public bodies to engage in derivative transactions, focusing on whether these are for hedging or speculative purposes. The capacity to contract is crucial, as without it, contracts are considered ‘ultra vires’ (beyond the powers) of the public entities involved. Second, the article highlights the role of court decisions in shaping public policy related to financial market practice, particularly in the use of derivatives by public bodies. These decisions not only address legal capacity but also broader systemic risks, emphasising the need for a balance between legal principles and minimisation of systemic risk in light of public bodies’ significant exposure to financial markets. Third, based on a review of case law, the article considers whether the distinction between hedging and speculation should be based on an objective test (focusing on the transaction’s nature and purpose) versus a subjective test (based on the entity’s intention). The article proposes an objective test and suggests that the distinction between hedging and speculation is critical in determining the legal standing and risks associated with the public body’s derivative transactions.