LONDON (Bloomberg) — HSBC Holdings Plc and UBS AG may be liable for as much as $3.2 billion of losses linked to Bernard Madoff in a dispute over the duties of financial custodians at funds in Luxembourg and Ireland.

At stake is the image of the European fund industry, French Finance Minister Christine Lagarde wrote in a January 12 letter to the European Commission and Luxembourg Prime Minister Jean-Claude Juncker. European funds' assets increased 59 percent to 6.8 trillion euros ($9 trillion) over the past six years, partly because rules protecting investors made them attractive.

"If they aren't required to pay the money, then investor protection doesn't mean anything and people might as well just invest in offshore funds," said Isabelle Wekstein-Steg, a lawyer at Wan Avocats in Paris who is representing 10 French retail investors and two institutions that face Madoff-related losses at Luxembourg funds. "UBS didn't do its job of knowing at all times where the assets were, and the same with HSBC."

Custodians are charged with oversight of funds, and they manage cash inflows and payments to investors. Those looking to recoup money would have to prove the banks failed to fulfill their duties, according to nine lawyers surveyed by Bloomberg News. HSBC has said it isn't liable and UBS declined to comment on the issue.

HSBC and UBS's custodian roles for the Luxembourg funds are limited because they were set up by investors specifically looking to place money with Madoff, said Paul Mousel, co-head of the financial services practice at law firm Arendt & Medernach in Luxembourg. He's representing both banks.

"The arrangements that were put in place from the beginning are arrangements that gave to the custodian a very, very, very small role to play, especially regarding the safekeeping of the securities, which allegedly would have been purchased by the investors' moneys," Mousel said.

Wekstein-Steg sent a letter on January 9 to Luxembourg's financial regulator on behalf of her clients requesting that custodians reimburse their investments.

It's impossible to say whether the custodian has any exposure without seeing the contracts of each fund, according to Julian Randall, a lawyer at Barlow Lyde & Gilbert LLP in London.

"What is clear is that there is unlikely to be any point to suing Madoff himself, and those who have lost money will be looking very hard at anyone, like HSBC, who was close to the action and also has assets," he said.

Thema International Fund Plc and AA (Alternative Advantage) Plc filed a lawsuit against HSBC on December 19 in Dublin's High Court, according to court records. The suit charges that HSBC wasn't able to confirm that assets in the funds were safe.

London-based HSBC has $1 billion of "potential exposure" after making loans to institutional clients who invested with Madoff, it has said. Madoff's firm collapsed last month after he told his sons it was a $50 billion Ponzi scheme, according to a complaint filed by the US Federal Bureau of Investigation.

HSBC spokesman Patrick McGuinness declined to comment beyond the company's December 15 statement that it "does not believe its custodial arrangement should be a source of exposure to the group".

UBS, based in Zurich, has said it doesn't have material exposure to Madoff's firm and declined to comment on the liability issue.