The Australian Securities and Investments Commission, which brought on the legal action after an investigation into the transaction, had told the court that the deal exposed Westpac's client to serious risk.
The court ultimately agreed, calling Westpac's actions as "unconscionable conduct" in its judgement.
Westpac will pay a penalty of $1.8 million, as well as $8 million for ASIC's legal and investigation costs.
"Westpac's behaviour was unconscionable and exposed its client to significant risk," said ASIC deputy chair Sarah Court.
"Westpac's conduct was also in stark contrast with several other banks."
The fine was the largest legally possible for the time of the offence.
The same conduct now could attract a penalty that's the larger of $782.5 million or three times the benefit derived.
Westpac made millions after pre-hedging without client consent
The detrimental conduct came when Westpac pre-hedged in advance of an interest rate swap transaction with a consortium acquiring electricity provider Ausgrid from the NSW government.
Despite concerns expressed by its client about how the pre-hedging could make the swap deal ultimately cost them more money, Westpac did it anyway without consent.
In doing so, the bank's derivatives trading desk made a trading profit of about $20.7 million on the day the swap was executed. The sales team directly received $3.7 million of commission.
To this day, the $12 billion interest rate swap remains the largest transaction of its kind in Australian history.
"This is a significant outcome which assists to clarify expectations regarding pre-hedging, particularly around disclosure and consent," said Court.
"Appropriate conduct for pre-hedging is an issue of global significance."
The Federal Court found that Westpac had inadequate mechanisms to manage the conflict between its own interests and the consortium's. The bank had not done enough to make sure the transaction was provided to the client "efficiently, honestly and fairly".
A Westpac spokesperson told The Motley Fool that the bank had "already taken action to strengthen processes and policies in relation to pre-hedging activity".
"Provision for the settlement was made in Westpac's 2023 financial year results."
The court reserved a decision as to whether Westpac will be ordered to complete a compliance program and an independent review into its pre-hedging practices.
The Westpac share price is down around 20% from January 2016.