In the recent case of, The State of the Netherlands (the “State of the Netherlands“) and Deutsche Bank AG (“DB“), the Court of Appeal (the “Court”) has confirmed that negative interest is not payable by the party transferring cash collateral (the “Transferor”) under the standard form of the ISDA 1995 Credit Support Annex (the “CSA”). This clarification is particularly important, as the lack of any express terms in the CSA with regard to the payment of negative interest has generated significant uncertainty leading to publication of the ISDA 2014 Collateral Agreement Negative Interest Protocol (the “Protocol”).
In 2001, the State of the Netherlands and DB entered into a 1992 ISDA Master Agreement Schedule and a 1995 CSA. The parties subsequently entered into a number of derivatives transactions.
Although the parties’ agreements predated the Protocol, the agreements were not amended in light of the Protocol. The parties had, however, amended the CSA so that only DB was required to provide credit support to the State of Netherlands, whilst the State of the Netherlands had no requirement to provide credit support to DB in the circumstance of a net credit exposure of DB to the State of Netherlands.
Since 2014, for the most part, the interest rate (EONIA minus 0.04%) to be paid by the State of the Netherlands to DB on cash collateral provided by DB had been negative. The central issue for the Court was whether DB, in addition to its requirement to provide cash collateral, was also required to pay ‘negative interest’, i.e. interest on that cash collateral if the interest rate was negative.
The State of the Netherlands argued that, while paragraph 5(c)(ii) of the CSA provided only for the transfer of positive interest to DB, other provisions of the CSA required that negative interest was accounted for. In essence, if the defined term of “Interest Amount” could include negative interest, the definition of “Credit Support Balance” required that that negative interest should form part of that Credit Support Balance (which is defined in the CSA as the balance to be transferred from the Transferor to the Transferee, in this case DB to the State of Netherlands).
DB’s position was that the sole operative provision relating to interest was paragraph 5(c)(ii) of the CSA, which directly spoke to the payment of interest at the times specified and elected by the parties in paragraph 11 (i.e. monthly or at the time of payment of a “Return Amount”). It was common ground that paragraph 5(c)(ii) imposed no obligation on DB (as Transferor) to pay negative interest. Had the parties intended for negative interest to be accounted for by way of a different mechanism, the logical place to include such wording would have been in paragraph 5(c)(ii).
Accordingly, DB argued that the definition of “Interest Amount” should be read in light of paragraph 5(c)(ii). DB contended that the purpose of the words “not transferred pursuant to 5(c)(ii)” was to ensure that the sentence was only referring to “Interest Amounts” that fell within, or were transferable pursuant to, paragraph 5(c)(ii). In support of its construction, DB also referenced the fact the Protocol (which albeit did not automatically apply to the parties’ bespoke contract) envisaged considerable amendment to paragraph 5(c)(ii) if adopting parties wished to address negative interest.
The Court dismissed the State of the Netherlands’ appeal, holding that on its true interpretation, the CSA could not be taken as providing for the payment of negative (as opposed to positive) interest.
The Court gave a number of key reasons in its judgment, holding that:
- paragraph 5(c)(ii) of the CSA covered positive (but not negative) interest. This paragraph was the most obvious place to find a reference to negative interest, had it been the parties intention. The fact that negative interest had been expressly excluded from paragraph 5(c)(ii) was a powerful indicator that it was not contemplated as payable;
- in consideration of interpretation, the Court relied on the User’s Guide to the ISDA Credit Support Documents under English Law (published in 1999), including a Best Practice statement published by ISDA (the ‘Statement”) just after the parties CSA was amended in 2010. The Statement said in express terms that interest rates under the CSA should be floored at zero and not drop into a negative figure. Although courts generally do not consider post-contractual documentation for use in interpretation (as this is usually outside the scope of the factual circumstances of the case), the Court considered the materials as significant because it showed ISDA’s thinking around the time the CSA was drafted, and thus what the general consensus would have been; and
- reading the CSA as a whole, the Court could see nothing that gave the impression that negative interest was contemplated or intended. Excluding negative interest was not unfair to the State of the Netherlands, as it was argued, as it was simply a consequence of what was actually agreed and not agreed in negotiations.
Where parties have not expressly agreed how to address negative interest rates, this judgment confirms once again that, in a negative interest environment, there is no obligation to pay or otherwise to account for negative interest.
It is therefore very important to expressly address this issue in negotiations and subsequently within collateral documents themselves, given the climate for both low or negative interest rates. In fact, it is now standard practice for parties to insert negative interest provisions in their collateral documentation, whether it is the 1995 or the 2016 CSA or other standard documents. Additionally, the Protocol reflects the need for clarity over how negative rates and the payment of interest on posted collateral should be treated in standard collateral documentation.
Expressly adhering and signing up to the Protocol on ISDA’s website provides one method by which parties to a CSA (or other ISDA specified collateral standard documents) may address negative interest rates. Alternatively, parties can include express negative interest provisions in their CSA (or other ISDA specified collateral standard documents), so that they are obliged to account for negative interest, should it apply to the collateral exchanged by the parties.
For more information, and any guidance or advice on drafting your ISDA and CSA documentation, Cleveland & Co External in-house counsel, your specialist outsourced legal team, are here to help.