Derivatives Alert: Appeal Fails on Negative Interest under CSA
In a short judgment published on 2 May, the English Court of Appeal dismissed the appeal by the State of Netherlands against a decision by the High Court that the English law CSA "does not contemplate a legal obligation to account for negative interest".
In our original alert on the case, we set out the reasons for the High Court decision1. It will be recalled that the State had contended that the provisions of the CSA – and in particular the definition of 'Interest Amount' and 'Credit Support Balance' - were to be treated holistically, requiring that negative interest should "form part of that Credit Support Balance". It will also be recalled that Deutsche Bank, while accepting that the definitions of 'Delivery Amounts', 'Return Amounts' and 'Credit Support Balance' were capable of being read so as to allow for negative interest, had contended that they should only be so read if the parties had made clear in paragraph 5(c)(ii) (whether by adherence to the ISDA Negative Interest Rate Protocol or otherwise) that negative, as well as positive, interest was in fact payable. The High Court agreed with Deutsche Bank.
On appeal the Court of Appeal agreed with the High Court. In doing so, it was swayed in part by a number of Best Practice Statements that had not been made available to the lower court judge and indeed were issued after the CSA between the State of Netherlands and Deutsche Bank was entered into. That is an unusual approach for an English court to take but, in this case, it did help to demonstrate how the industry had changed its view on negative interest over time. The earliest Best Practice Statement (predating the ISDA Negative Interest Rate Protocol by several years) stated that "[a]t no point should the interest accrual (rate minus spread) drop into a negative figure. If this occurs the rate should be floored at zero". Later Practice Statements (also predating the ISDA Negative Interest Rate Protocol) added "[i]n the circumstance where market conditions cause the interest accrual (rate minus spread) to drop to a negative figure and the CSA is not explicit on the flooring of interest rates, parties should bilaterally agree interest accrual handling" and subsequently that "…..the parties should consult and decide how to address negative interest rates".
Interestingly, the Court of Appeal considered that the alternative interpretations of the contractual provisions of the standard CSA put forward by the State and Deutsche Bank were both credible and not determinative. Instead they looked (a) at the Best Practice Statements and (b) at the fact that, because any transfers of Interest Amounts were not subject to the Minimum [Transfer] Amount (of EUR 1 million) or the rounding provisions, this created an inexplicable disparity between the way in which positive and negative interest would be accounted for if negative interest formed part of the Credit Support Balance but there was no obligation to pay it other than through Return Amounts.
The decision is a welcome confirmation of the legal position even though it may now require those market participants who have perhaps been accounting for negative interest pending the Appeal Court's ruling to re-calibrate their positions accordingly. We discussed in more detail the potential consequences of this appeal in our second alert on the case.
It remains to be seen if the State will appeal to the Supreme Court.
If you would like to discuss the case or the implications of it, please get in touch with your usual Fieldfisher contact.
1The State of the Netherlands v Deutsche Bank AG [2019] EWCA Civ 771 (2 May 2019)
On appeal the Court of Appeal agreed with the High Court. In doing so, it was swayed in part by a number of Best Practice Statements that had not been made available to the lower court judge and indeed were issued after the CSA between the State of Netherlands and Deutsche Bank was entered into. That is an unusual approach for an English court to take but, in this case, it did help to demonstrate how the industry had changed its view on negative interest over time. The earliest Best Practice Statement (predating the ISDA Negative Interest Rate Protocol by several years) stated that "[a]t no point should the interest accrual (rate minus spread) drop into a negative figure. If this occurs the rate should be floored at zero". Later Practice Statements (also predating the ISDA Negative Interest Rate Protocol) added "[i]n the circumstance where market conditions cause the interest accrual (rate minus spread) to drop to a negative figure and the CSA is not explicit on the flooring of interest rates, parties should bilaterally agree interest accrual handling" and subsequently that "…..the parties should consult and decide how to address negative interest rates".
Interestingly, the Court of Appeal considered that the alternative interpretations of the contractual provisions of the standard CSA put forward by the State and Deutsche Bank were both credible and not determinative. Instead they looked (a) at the Best Practice Statements and (b) at the fact that, because any transfers of Interest Amounts were not subject to the Minimum [Transfer] Amount (of EUR 1 million) or the rounding provisions, this created an inexplicable disparity between the way in which positive and negative interest would be accounted for if negative interest formed part of the Credit Support Balance but there was no obligation to pay it other than through Return Amounts.
The decision is a welcome confirmation of the legal position even though it may now require those market participants who have perhaps been accounting for negative interest pending the Appeal Court's ruling to re-calibrate their positions accordingly. We discussed in more detail the potential consequences of this appeal in our second alert on the case.
It remains to be seen if the State will appeal to the Supreme Court.
If you would like to discuss the case or the implications of it, please get in touch with your usual Fieldfisher contact.
1The State of the Netherlands v Deutsche Bank AG [2019] EWCA Civ 771 (2 May 2019)