Hedging: where is the dividing line?

Herbert Smith Freehills LLP have published an article in Butterworths Journal of International Banking and Financial Law on the legal distinction between internal and external hedging.

Hedging is a risk management practice commonly adopted by financial institutions and corporations to manage their exposure to risks like movements in interest rates, currency fluctuations, or commodity price fluctuations.

To hedge its risk exposure, a party can choose to use internal or external hedging arrangements. The distinction between "external" and "internal" hedging is simple, and relates to the relationship between the counterparties to the hedge.

The English courts also recognise that there is a distinction between internal and external hedging, which has consequences for the calculation of losses in breach of contract claims. This was discussed recently in Rhine Shipping DMCC v Vitol SA [2023] EWHC 1265 (Comm) and [2024] EWCA Civ 580, which concerned a dispute over the effect of internal hedging on the assessment of causation and loss for a breach of contract. 

In this article, we consider the implications of this legal distinction and practical steps to mitigate any associated litigation risks.

The article can be found here: Hedging: where is the dividing line? This article first appeared in the April 2025 edition of JIBFL.