The treatment of negative interest rates in market standard documentation remains a current topic in the climate of falling interest rates.
UK Court of Appeal Decision
On 2 May 2019 judgment was given by the UK Court of Appeal in The State of the Netherlands v Deutsche Bank. This was an appeal by the Netherlands against a ruling of the Commercial Court that, where “negative interest” arose in respect of a deposit made under a credit support annex entered into in connection with an ISDA Master Agreement, the depositor was not obliged to make a payment in respect of that negative interest amount to the depositee.
In its judgment the Court accepted that interpretations advanced by both parties had merit and could have been valid interpretations of the terms of the credit support annex. However, whilst both parties had also argued the contract could have clarified the issue being raised either way, and this was highlighted by the Court, the Court stated that it was thought “more important to look carefully at what the drafting did include, rather than what it did not”.
In finding against the Netherlands, the Court also based its analysis on:
- the need to consider the contract and its context as a whole and that in doing so “the impression that negative interest was contemplated or intended” was not given to the Court; and
- notably, the 2010 ISDA Best Practice Statement, a guidance issued shortly after the latest version of the contractual documentation between the parties, as well as changes to the guidance and approach by ISDA between their user guide issued in 1999 and statements made after that date.
The decision of the Court (dismissing the appeal against the first instance judgment, albeit on different grounds) and finding that negative interest was not payable on a true interpretation of the credit support annex, confirms that, unless specifically provided for in relevant ISDA documentation, negative interest will not be payable by one party to another.
Since the date on which the credit support agreement (the subject of this case) was entered into, the treatment of negative interest in the derivatives market has developed. ISDA published its 2014 ISDA Negative Interest Protocol giving market participants an option to automatically amend certain collateral agreements to cater for the payment of negative interest. Relevant parties can also agree to amend cash collateral agreements not covered by the protocol to incorporate similar provisions.
It also remains to be seen whether the approach taken by the Court having reference to ISDA guidance notes will be applied more widely.
Impact & Clarification – Loan Agreements
Parties using LMA style loan agreements may be able to take comfort from this judgment given that:
- the LMA precedents have provided for optional base rate zero floor language for a number of years; and
- the market view has been that a negative base rate would erode the margin but not result in negative interest being payable given that the LMA loan documentation does not contemplate a lender paying interest to a borrower.
It remains to be seen whether the case will result in parties seeking to make amendments to LMA style documentation to explicitly exclude the impact of negative base rates. On the basis that the Court of Appeal considered that:
- the first instance judgment adopted “too simplistic an approach” in treating negative interest as not being payable simply on the basis it was not explicitly provided for; and
- it was necessary to view the documentation as a whole,
A conservative lender in a low margin situation could look to explicitly exclude the impact of negative base rates as an addition to adopting the LMA base rate zero floor language, although this would be a move away from the market.