A significant number of development banks, supranational organisations and other entities established by international treaties enter into over-the-counter (OTC) derivative transactions. This update sets out some key considerations for parties proposing to enter into OTC derivative transactions with such international organisations. These considerations are additional to the usual legal, credit and tax issues to be considered as a matter of course before transacting with any counterparty.
The frequency with which the English courts are called on to consider an entity's capacity to enter into a derivative transaction is indicative of the importance of this issue. Detailed analysis is often required in relation to the capacity of international organisations. For the purposes of English law, the question is essentially twofold:
- Does the international organisation have legal personality?
- Does the international organisation have sufficient capacity to enter into derivative transactions of the proposed type?
Legal personality and capacity of international organisations generally
The first question is important because English courts generally do not have jurisdiction to enforce rights and obligations which arise pursuant to international treaties. As such, an English court cannot recognise an international organisation as having legal personality, and thus the ability to sue and be sued before it, where that legal personality is said to derive from a treaty alone.
The legal personality of certain international organisations is recognised for the purposes of English law pursuant to the International Organisations Act 1968, which provides for the "legal capacities of a body corporate" to be conferred on organisations by the crown by order in council. A number of organisations, including the African Development Bank,(1) have been conferred with legal personality in this manner.
However, many international organisations have not been conferred with legal personality pursuant to the act. An English court may still recognise the status of an international organisation in these circumstances, provided that it has been incorporated by at least one foreign state and that state itself recognised by the crown.(2) It may be expected that the state in which an international organisation has its headquarters will recognise the organisation as having legal personality, but this cannot be assumed and local legal advice should be sought.
Capacity to undertake specific transactions
Similarly, it cannot be taken for granted that an international organisation which would be recognised by an English court as having legal personality necessarily has the capacity to enter into OTC derivative transactions, or at least OTC derivative transactions of all kinds. Whether an international organisation has the requisite capacity to enter into a particular transaction is a question of its constitution and public international law.(3) It is not necessarily the case that an international organisation's capacity is equivalent to the capacity of a corporation in the state in which the relevant organisation is recognised as having legal personality for the purposes of English law. Each international organisation's constitution will differ, in both its terms and its form, and an international organisation's constitution often will not make express provision for entry into derivative transactions. Therefore, the question of capacity must be considered on a case-by-case basis and often by reference to any indirect or general powers of the relevant international organisation. Necessarily, the analysis frequently results in reliance being placed on an interpretation of the international organisation's constitution.
In many cases banks and financial institutions will elect to modify their standard documentation in order to mitigate the risk that their international organisation counterparty may not have capacity to transact. Where parties transact on the basis of an International Swaps and Derivatives Association (ISDA) master agreement (and assuming that the international organisation has capacity to enter into an ISDA master agreement itself), the representations in Section 3(a) of the ISDA master agreement will not necessarily provide adequate protection against the consequences of an international organisation entering into a transaction which is outside its capacity. That is principally because these representations will not be deemed to have been repeated by a counterparty where it purports to enter into a transaction which it has no capacity to enter into. However, if an international organisation has provided additional warranties as to its capacity which can be said to represent an agreed state of affairs in respect of future transactions, it may be estopped from later seeking to resile from that agreement.(4) This may allow for close-out under the ISDA master agreement as if any ultra vires contracts were in fact valid. Alternatively, this may provide the basis for a claim in damages for breach of warranty. Therefore, careful consideration should be given as to whether it would be beneficial to seek additional warranties before transacting with an international organisation and the precise form that they should take.
On the assumption that the question of capacity can be satisfactorily addressed, a key matter to consider is whether the close-out netting provisions of the ISDA master agreement would be enforceable against the relevant international organisation counterparty.
The netting opinions available to ISDA members do not usually cover international organisations, so it will usually be necessary to consider the question on a case-by-case basis. It is generally helpful to do this in two cases: where the international organisation counterparty is solvent and where it is insolvent. The term 'solvent' is used here in a general manner as there is no 'one size fits all' test for determining the solvency of international organisations.
Of the two analyses, the position on insolvency is often less certain. In many cases, it will be unclear which courts, if any, would have jurisdiction in respect of the insolvency of the international organisation, and therefore how any insolvency would be administered. Notwithstanding the technical legal position, the insolvency of an international organisation can be expected to have significant political ramifications and the treatment of creditors' claims would probably depend on the circumstances at the time. In practice, it is often impossible to avoid these risks through the relevant documentation. To mitigate the risk, counterparties may consider including additional termination rights in their documentation to allow close-out prior to insolvency where the circumstances of the international organisation counterparty are deteriorating or its prospects are uncertain. Similarly, counterparties may require additional collateral against their exposures. However, the ability to negotiate these terms may be limited by a strong bargaining position of the international organisation.
If the international organisation counterparty is solvent at the point of early termination, enforceability of the close-out netting provisions is determined primarily by the law of the contract. As a matter of English law, there may be no reason as to why the close-out netting provisions are not, as a matter of principle, enforceable against an international organisation counterparty; but again, this needs to be considered on a case-by-case basis.
Notwithstanding that an international organisation may have legal personality and capacity to enter into OTC derivative transactions, and that the terms of the transactions themselves are binding on the international organisation, consideration should be given before transacting as to how the terms of those transactions could be enforced should it become necessary to do so.
A key consideration in this regard is the question of immunity. An international organisation's constitutional documents may purport to grant it immunity from suit and/or its assets immunity from execution. However, whether an international organisation can actually rely on immunity from suit in proceedings before an English court or an arbitral tribunal would depend on the status of the organisation itself and the terms of the agreement being enforced, among other things. Accordingly, it is important to consider the question of immunity before transacting. As part of this process, thought should be given to the proposed forum for resolving disputes and to whether any waivers of immunity may be necessary or desirable.
The other key consideration is whether effective enforcement action could be taken against the international organisation's assets. This is largely a question of the applicable law in the jurisdiction(s) where enforcement is sought. Local legal advice should be sought in relation to this point before transacting. In some instances, it may be desirable to provide for the parties to collateralise their positions and/or for security to be provided in respect of designated and realisable assets.
International organisations have not gone unaffected by regulatory developments in the OTC derivative markets in recent years. The EU European Market Infrastructure Regulation (648/2012) makes provision to bring certain international organisations outside its scope (except in relation to the reporting obligation), but other international organisations and counterparties which trade with them must consider their position on a case-by-case basis. This may involve difficult analysis, particularly in terms of classifying an international organisation within the confines of the terminology used in the regulation. From the perspective of international organisations looking to trade with counterparties which are subject to the regulation, advice may be required in relation to terms which the counterparty may request for the purposes of complying with its regulatory obligations. This adds cost to the process of documenting derivative transactions and potentially causes delay while terms are agreed; more fundamentally, it can result in international organisations assuming additional administrative duties in relation to their derivatives trading activity.
For further information on this topic please contact Markus Burgstaller, James Doyle, Oliver West or Isobel Wright at Hogan Lovells International LLP by telephone (+44 20 7296 2000) or email (firstname.lastname@example.org, email@example.com, firstname.lastname@example.org or email@example.com). The Hogan Lovells International LLP website can be accessed at www.hoganlovells.com.
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