The Court considered whether the provider of cash collateral, under an unadulterated (save for usual paragraph 11 elections and variables) English law ISDA 1995 Credit Support Annex (Bilateral Form – Transfer), is obliged, absent an express provision to such effect, to pay interest to the holder of the cash collateral in circumstances where the rate stipulated in the CSA is negative. The Court, for a variety of reasons based on established principles of contractual interpretation, concluded that the cash collateral provider is under no such obligation.
The case concerned a CSA between Deutsche Bank ("DB") and the State of the Netherlands (the "State"). The CSA was one-way in effect, obliging DB to provide cash collateral to the State to the extent that the State was net in-the-money under the various transactions outstanding under the ISDA Master Agreement between them (also governed by English law). The contractually agreed interest rate stipulated in the CSA is and has for some time been negative. The NI Protocol was not applicable.
The State argued that DB should pay negative interest to it on the cash collateral. There was no express provision to that effect in the CSA, so the State claimed that accrued but unpaid interest (including negative interest) was to be included in the calculation of the Credit Support Balance (as defined in the CSA) and was therefore to be accounted for in the calculation of other amounts (i.e. Delivery Amounts and Return Amounts) payable between the parties. Those familiar with the workings of the CSA will appreciate the force of the argument. The State also argued that the commercial purpose of the CSA (which provides for an amount equal to the value of the Credit Support Balance to be included as an Unpaid Amount) was to protect it from a DB default and used that fact to argue for commercial "equivalence" in the treatment of interest.
The State additionally relied on ISDA's 2013 Statement of Best Practice for the OTC Derivatives Collateral Process (which contains a principle setting out that the parties should consult and decide how to address negative interest rates) and the NI Protocol.
DB's position was simply that, if the parties had wanted to address negative interest, they should have done so expressly. DB also relied on a statement in the ISDA User's Guide to the effect that paragraph 5(c) of the CSA provides that the Transferee will pay interest on any cash collateral at the agreed rate (which may be zero).
The Court decided in favour of DB for the following reasons:
the approach to interpreting the CSA should follow usual contractual principles and should be no different to the approach adopted by the Court in Firth Rixson in relation to interpretation of the ISDA Master Agreement – in other words, the Court will look at the language employed and investigate the commercial consequences and will do so in a manner that serves the objectives of clarity, certainty and predictability
the State had to show that there was an obligation on the part of DB in respect of negative interest, but had failed to do so – there was no such obligation
in this regard, paragraph 5(c)(ii) of the CSA was of no help – it contemplated only (and unless otherwise specified – another factor) the transfer of interest by the person holding the collateral to the person who posted it; it did not require the person who posted the collateral to pay interest to the person holding it
as for the State's 'Credit Support Balance' argument, this would necessitate concluding that positive interest should be dealt with in one way (through direct payments) but that negative interest should be dealt with through the (different) accounting machinery of the Credit Support Balance – a conclusion that had "no credible commercial rationale"
as for the State's "equivalence" argument, the Court noted that it was not necessarily the case that the State would incur loss by holding cash in a negative interest rate environment and that it was free to invest the cash to earn interest elsewhere
the ISDA materials on which the State sought to rely post-dated the ISDA Master Agreement, were not in the parties' contemplation and could not therefore assist in its interpretation; by contrast the User's Guide on which DB sought to rely was an aid to interpretation
All in all this is a sensible and expected outcome which addresses uncertainties that have existed for some time in the market as to how negative interest should be dealt with in the absence of express contractual provisions and where the NI Protocol is not in play.
There are broader consequences and implications of this decision however.
One of the issues that has given rise to long-dated disputes and "agreements to disagree" in the market is the fact that under IFRS parties have had to book P&L against the cost or benefit of collateral under CSAs. Whether interest is or would be payable in a negative interest environment has a material impact on that determination which, for many market participants, has led them to prefer not to have a definitive decision on the issue. The fact that a court has now decided in this regard is likely to make it difficult to sustain a position that negative interest is or would be payable, thereby resulting in provisions or the reversal of provisions being made in an institution's books.
The principle in this case is not just relevant to negative interest under CSAs but will be of practical application to all forms of financial contracts that provide for the payment of interest and should encourage parties to address the issue of negative interest in relation to both legacy and future transactions.
In view of these considerations it will be interesting to see if there is now an appeal or further cases brought which seek to achieve a different outcome by advancing different arguments or taking the issue to a higher level of Court.
If you would like to discuss this case or the implications of it, please get in touch with your usual Fieldfisher contact.
1The State of the Netherlands v Deutsche Bank AG  EWHC 1935 (Comm) (25 July 2018)
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