There is currently no international court to handle Madoff-scale fraud cases or cross-border disputes between the world's biggest banks. A few lawyers are starting to imagine what one might look like. Michael Goldhaber reports

Rivers of ink have been spilled on designing a regulatory response to the global financial crisis. On global financial dispute resolution, not so much.

"The newspapers are full of stuff about regulation," complains derivatives guru Jeffrey Golden of Allen & Overy (A&O). "But there's not a word about judges and courts. The whole focus is on preventive medicine, and nobody's paying attention to the hospitals full of sick patients." By sick patients, Golden means banks caught in litigation over structured finance.

An obscure but audacious Dutch not-for-profit organisation, the World Legal Forum (WLF), has heard Golden's cry, and is taking steps to create a sick ward for banks with a legal complaint, be it a sore swap, an aching put or a festering option. Independently, lawyers for fraud victims of Bernard Madoff have called loudly (and until now, vaguely) for a world financial court.

These two camps, themselves divided, are addressing utterly distinct problems. In one arena are sophisticated banks, which were counterparties in legal but opaque transactions that resulted in huge losses, and who differ over novel questions of valuation, marketing, priority and risk-bearing. In the other arena are naive consumers who were victims of a naked criminal fraud. Yet each group is dissatisfied with the status quo of dispute resolution by a hodgepodge of domestic courts. Converging visions may ultimately bring them together to establish a forum for global financial disputes.

The financial wizards of the derivatives issuers' trade group, the International Swaps and Derivatives Association (ISDA), have regarded national courts as a poison pot since at least 1991. It was then that the UK law lords undermined their business with a surprise ruling in the Hammersmith and Fulham case that British local authority lack the power to trade in derivatives.

The ISDA sees national judges as uniquely dangerous in this context for two reasons. First, most judges are financial novices. Second, even one bad derivatives ruling can taint every derivatives deal, because all rely on the same ISDA master contract. To these unique concerns might be added the general anxiety that national judges will protect domestic parties.

These risks were largely academic during the long boom. But the crisis that erupted after the fall of Lehman Brothers has stoked discontent in myriad ways, and the taboo on interbank suits has lifted. The early wave of derivatives claims has pit Barclays Bank versus JP Morgan Chase; HSH Nordbank versus UBS; and M&T Bank versus Deutsche Bank.

ISDA saw confirmation of its fears about national courts in the South Korean 'Kiko' cases, which revolve around a financial product known as a 'knock-in, knock-out' contract. South Korean exporters lost big on their foreign exchange derivatives when the US dollar soared against the Korean won in the six months starting October 2008. More than 300 lawsuits ensued. By April 2009 the Seoul central district court had preliminarily suspended seven Kiko contracts (while denying 14 similar applications). The ISDA was flabbergasted when some of the contracts were terminated by the court based on the wild card doctrine of "changed circumstances".

International arbitration is the traditional alternative for litigants shy of national courts. But financial players (to the extent that they ever sued each other) have generally avoided international arbitration until now, for a few reasons. First, there is a widespread belief – which international arbitrators universally call a myth – that arbitrators tend to split the baby, whereas banks tend to want all their money back.

Second, finance has until recently been so dominated by the US and the UK that American and British parties had the market power to demand use of their own courts, even if the dispute was not entirely domestic. Third, there has never been a concerted effort to tailor global arbitration for banks.

Enter Golden, one of the founders of the ISDA and now US special counsel at A&O. Golden is a deal lawyer's deal lawyer, but as an expert witness he has had plenty of opportunity to witness dysfunctional national courts. In December 2007 in The Hague he issued a clarion call to reform global financial disputes, addressing the inaugural meeting of the WLF, a think tank on international business law launched by the Dutch Government and legal community.

The Hague is a natural draw for international legal dreamers, because it boasts the infrastructure for global tribunals. Lawyers like Gerard Meijer of the Dutch firm NautaDutilh, who advises the WLF, argue that The Hague is slowly emerging as the capital of international law, in much the way that Wilmington, Delaware, serves as the capital of corporate law.

The Hague's greatest asset is neutrality. "Emerging market parties may see America or London as the places where some of these financial problems occurred," and may question the objectivity of a US – or UK – dominated forum, argues Frank Zwetsloot, who directs the WLF. Golden does not see eye-to-eye with Zwetsloot on every point, but he's sold on The Hague.

Zwetsloot and his colleagues responded to Golden's call for reform with a March 2009 report that examined options for global financial dispute resolution. The five options reviewed were: mediation; arbitration conducted on an ad hoc basis (without the supervision of an institution); arbitration supervised by the Permanent Court of Arbitration (PCA), a Hague-based dispute resolution institution founded by treaty in 1899; arbitration under the auspices of a new treaty; or adjudication under the auspices of a new treaty.

Zwetsloot essentially dismisses a new treaty as politically impossible. He sees a new chamber in the PCA, requiring the agreement of all of the institution's 109 member nations, as a difficult long-term goal. Mediation is a limited solution, because it lacks precedential value. That leaves ad hoc arbitration as the main focal point of the Dutch initiative.

In March the WLF preliminarily recommended establishing a facility offering both mediation and arbitration, to be called the Financial Legal Expertise Centre. The idea is moving forward in earnest, with a formal proposal to be presented at a December seminar that the WLF is convening at the European Central Bank in Frankfurt. At the core of the proposal will be a list of 50 to 100 financial industry experts to serve as arbitrators in ad hoc arbitrations under United Nations Commission on International Trade Law (UNCITRAL) rules, with the PCA as appointing authority.

"The essence of this initiative is to get the best financial experts involved," says Zwetsloot. He hopes to have the list operational in early 2010, in plenty of time to handle disputes arising from the financial crisis.

Golden is working closely with the group, but he worries that arbitration is only a partial solution: arbitration may not solve the precedent problem. "Ad hoc arbitration has been just that – too ad hoc," Golden writes in a working paper. "The issue that hangs over all of us is how to get a settled body of precedent in financial law," he adds in an interview.

Zwetsloot responds that arbitration will build a body of law – so long as it is published. One need only look at state-investor arbitration to see that published judgments can be cited by advocates and arbitrators just like judicial rulings. The challenge is to persuade parties to agree to publication.

Yet Golden (pictured) still finds himself wondering: "Do we need a world court of the financial markets?" Halfway around the globe, another lawyer has been pondering a similar question.

Gaytri Kachroo's most famous client is Harry Markopolos, the would-be whistleblower who called Bernard L Madoff Investment Securities a Ponzi scheme nearly a decade ago. Now Kachroo, a solo practitioner, also represents some of Madoff's victims – including a Japanese investor whose trail of money linked to Madoff runs through funds and sub-funds in Switzerland (Royal Bank of Scotland Group), Britain (Barclays Bank), the Cayman Islands (Kingate Management) and the US (Fairfield Greenwich Group). This sort of global tangle baffles clients, lawyers and judges alike. Kachroo is unsure which, if any, existing Madoff lawsuit fits her client. "Can we get into the Fairfield class action?" She asks. "Can we get into the Kingate class action? The answer is, 'We don't know'."

Kachroo is not the only lawyer facing similar uncertainty. Javier Cremades of Madrid's Cremades & Calvo-Sotelo, who has helped to organise a coalition of Madoff victims' law firms known as the Madoff Lawyers' Alliance, projects 2,500 Madoff-related disputes in the courts of 17 nations by the end of 2009. Many Madoff lawyers would like to see a more systemic process.

The US and European branches of the Madoff Lawyers' Alliance are separately developing potential solutions – although it's looking increasingly likely that any forum they design for global financial disputes might have to wait to be rolled out until the next Madoff-size fraud. Kachroo has taken the lead in the US; in Europe, Cremades has tapped a leading Spanish academic, Rafael Illescas Ortiz of Universidad Carlos III de Madrid.

Kachroo has succeeded in inserting a potentially revolutionary seed in a relatively uncontroversial bill pending in the US Congress. The Support Investment Protection for Customers Reform Act of 2009 would expand the protection against securities fraud afforded by the Securities Investor Protection Corporation (SIPC) from $100,000 (£64,500) to $250,000 (£160,000), in line with expanded Federal Deposit Insurance Corporation (FDIC) coverage.

Section 4 of the bill, which Kachroo helped design, would create a one-year commission on International Financial Fraud, chaired by the Securities and Exchange Commission (SEC) inspector general, with representation from the US Departments of State and Treasury, the Federal Reserve Bank, SIPC and the Federal Bureau of Investigation, with one spot available for an outsider. This commission's task would be to propose an institution to handle international fraud claims.

What might such an institution look like? In contrast to other global courts, which are available only after parties fight it out in the domestic courts, Kachroo envisions disputes proceeding directly to the international level, at least during moments of crisis. International jurisdiction would be triggered automatically if a few simple conditions were met – for instance, if a fraud involving a certain sum of money crosses two national borders.

Her ideal court would allow class action certification, perhaps with a three-member panel vetting claims in a fashion similar to the US Judicial Panel on Multi-district Litigation. Fee shifting and litigation financing would follow the US model. Most breathtakingly, Kachroo can imagine a court with sweeping enforcement powers – including the right to subpoena witnesses and attach assets tainted by fraud.

The idea of any new treaty-based world court, let alone a fraud court with such sweeping powers, meets with widespread scepticism. Kiernan Bell of Appleby in Bermuda says that her clients, which include many leading Madoff defendants, would take a pass, especially to the idea of US-style class actions. "Even if I could see how it could be done practically," she says, "I'd need to be persuaded why litigants in private law matters would agree to be tried together." However, even Bell can imagine her clients readily embracing consensual arbitration.

Arbitration is the preference of Kachroo's European counterpart, Illescas, a longtime member and recent chair of UNCITRAL, the UN body that formulates the most influential rules for ad hoc arbitration. At the urging of Cremades and the European arm of the Madoff alliance, Illescas is formulating a proposal for a financial arbitration working group, to be considered by UNCITRAL at its next full meeting in July 2010.

Illescas envisions a new set of ad hoc arbitration procedures designed for financial fraud and a new list of expert arbitrators, perhaps with the PCA serving as the nominating body. In the long term, the professor tentatively suggests, he would like to see a new arbitration forum – perhaps a specialised chamber of the PCA. "The question of legitimacy is crucial in addressing financial fraud," says Illescas. At the same time, he admits that the creation of such a forum would be slow and arduous. "I suppose we will need an international treaty," he says, with some trepidation.

Though Illescas is a gradualist by nature, he dreams boldly in at least one important respect. As a longtime observer of arbitration, he complains that the national bankruptcy court stay provided for in the UNCITRAL arbitration model is paralysing. "We need to solve this situation," he says. "We need to have a power higher than a national court."

The near-term model of ad hoc arbitration by financial fraud specialists that Illescas advances sounds an awful lot like the WLF's near-term model of ad hoc arbitration by financial derivatives experts (and very little like the reinvent-the-world model of Illescas' nominal ally, Kachroo). Illescas and the WLF even share a tentative dream of creating a new arm of the PCA.

Both are open in theory to joining forces, though each stops well short of adopting a position or endorsing the other group's early-stage ideas. "ISDA transactions are very different from fraud," says Illescas, "but, in principle, the ideas for such courts could be combined. In a very large political process, a conjunction of wills is necessary."

The WLF sees ISDA disputes as the base of its new arbitration centre, but there is no reason that the facility couldn't be used by parties with other sorts of financial grievances. The two camps will have an opportunity to converge further at the WLF seminar in December, which will feature both Golden and Illescas as speakers.

Bankers might scoff that the Madoff "financial" scandal has little in common with tussles over complex "financial" products, except that these disputes coincided in time, and have something to do with money crossing borders.

But, to take another historic example, the victims of the Oklahoma City domestic "terror" bombing and the victims of the Lockerbie "terror" bombing shared little except semantic shorthand. Yet somehow, in 1996, those groups came together in Congress to pass the Antiterrorism and Effective Death Penalty Act. Politics make strange bedfellows, and so do crises.

A version of this article first appeared in The American Lawyer, Legal Week's US sister title.