CSA negative interest

Summary

The High Court of England and Wales has held that a Credit Support Annex in the form of the 1995 ISDA Credit Support Annex (Transfer – English law) does not require a party that has posted collateral in the form of cash to pay or account for negative interest to the recipient of that collateral.

Background

The State of the Netherlands (the State) and Deutsche Bank (Deutsche Bank) had entered in to a number of derivatives transactions under an ISDA Master Agreement which included a 1995 ISDA Credit Support Annex (Transfer – English law) (the Agreement). At the relevant time, there was a net exposure of the State to Deutsche Bank and accordingly Deutsche Bank had transferred collateral to the State. This collateral was provided in the form of cash and the applicable interest rate on this cash meant that, for a period of time, the interest rate on this collateral was negative.

The Agreement predated and did not incorporate the 2014 ISDA Collateral Agreement Negative Interest Protocol.

The State’s claim

The State contended that the Agreement required Deutsche Bank to account to them for negative interest on cash that had been posted to the State. It is notable that the State did not claim that this amount was payable by Deutsche Bank pursuant to the interest payment provisions of the Credit Support Annex (Paragraph 5(c)(ii)) but instead argued that amounts of negative interest should be taken into account through the definition of “Credit Support Balance”.

The Credit Support Balance of a party represents the adjusted value of collateral that has been posted by that party to the other and that has not been returned. The definition of “Credit Support Balance” includes the following wording:

“Any Equivalent Distributions or Interest Amount (or portion of either) not transferred pursuant to Paragraph 5(c)(i) or (ii) will form part of the Credit Support Balance.”

The State argued that this wording required accrued interest to be taken into account whenever the Credit Support Balance was determined. They argued that this was the case regardless of whether the accrued interest amount was negative or positive, such that an amount of accrued negative interest would reduce the Credit Support Balance and require Deutsche Bank to post additional collateral beyond that which would otherwise be required on such day.

The decision

The court held that the State failed to demonstrate that the Agreement contained an obligation on Deutsche Bank in respect of negative interest.

Although the definition of “Interest Amount” is capable of giving rise to a negative figure, there is no requirement in Paragraph 5(c)(ii) to pay negative interest and the court did not agree that such an obligation could be implied in to the terms of the Agreement through the definition of Credit Support Balance:

“The argument for the State contemplates that while a positive sum by way of interest will be dealt with through the machinery of paragraph 5(c)(ii), a negative sum by way of interest is dealt with through a different machinery. There is no credible commercial rationale for the parties to have made such a choice; if they wanted to deal with negative interest then bringing it into paragraph 5(c)(ii) was the obvious course. Nothing points in the design of the different machinery on which the State relies to that machinery being designed for handling amounts of negative interest.” (per Mr Justice Robin Knowles CBE at 30)."

This decision supports the commonly accepted market position on the treatment of negative interest under the 1995 ISDA Credit Support Annex (Transfer – English law). Parties seeking a different treatment of negative interest should deal with this specifically in Paragraph 11 to their Credit Support Annex or should ensure that both parties have adhered to the 2014 ISDA Collateral Agreement Negative Interest Protocol.