In a climate of low interest rates, is negative interest automatically payable? (The State of the Netherlands v Deutsche Bank AG)

In The State of Netherlands v Deutsche Bank AG [2018] EWHC 1935 (Comm), the judge confirmed that a standard International Swaps and Derivatives Association (ISDA) Credit Support Annex (CSA) does not include an obligation on a Transferor to account for negative interest, where the ISDA 2014 Collateral Agreement Negative Interest Protocol has not been explicitly incorporated.

What are the practical implications of this case?

This case confirms that the provisions of a standard agreement must be read as containing all information necessary to the parties. It follows that if the parties intend to deviate from the standard agreement they must specifically state this in the documentation or subsequently amend it; obligations will not be imposed by the court later. In this case, the point of interest was whether there was an obligation for Deutsche Bank (DB) to pay negative interest on deposits where usually the State of the Netherlands (the State) would be paying the interest in a positive interest environment. If parties want to benefit from negative interest rates, they must clearly amend their contract to reflect that they intend to do so, if not already set out within it. The ISDA master agreement is a standard form agreement and certainty of that contract is important and so the judge reiterated that words cannot be implied into the contract where they do not exist.

For practitioners this is a helpful case in confirming that where parties enter into standard form agreements, they can be confident that judges will not agree that terms are implied in the contract unless explicitly set out. In this instance, ISDA had published a protocol on negative interest rates, after the agreement had been entered into. It was for the parties to adhere to the Protocol and amend their CSA accordingly to reflect the provisions within that protocol if they wanted the provisions to apply to these transactions.

What was the background?

The State and DB entered into a 1992 ISDA Master Agreement and CSA in 2001, with the CSA being amended in 2010.

The CSA set out that where the State had a net credit exposure to DB, DB should provide credit support to the State. However, it was not set out that the reverse was true (ie that if DB had a net credit exposure to the State, that the State should provide credit support to DB).

The current situation was that the State had a net credit exposure and interest was due to be paid by the State to the Bank. However, the agreed rate had been less than zero for most of the time since June 2014.

The question raised was whether the Bank had to pay ‘negative interest’ (ie interest from the party who provides a principal sum for a period of time, rather than the party receiving it and having use of it).

The State argued that although DB was not obligated to transfer the interest amount to it, the accrued but unpaid interest (including the negative interest) should be included in the calculation of the Credit Support Balance. The State argued that the Interest Amount for an Interest Period is produced by summing all positive and negative amounts of daily interest. It was argued that even where the aggregate of daily amounts over a month is negative, even though that means the State does not have to pay interest, those daily accruals still exist and should not be ignored when calculating the Interest Amount for the Interest Period ending when interest is next paid and that negative daily accruals should be taken into account when calculating the Credit Support Balance. The Credit Support Balance should be increased and decreased by the amount of positive and negative accrued interest (respectively). Positive accrued interest will reduce the Delivery Amounts and increase the Return Amounts and negative accrued interest will have the converse effect.

The State also emphasised that the CSA is designed to ensure that the State has credit protection in the event of termination for default of any transactions entered into under the ISDA master agreement, which is why, the State argued, Paragraph 6 of the CSA sets out that an amount equal to the Credit Support Balance should be included as an Unpaid Amount in the calculation of the sum due on termination.

The State relied on two ISDA materials to back up its argument. One of it which was the 2013 Statement of Best Practice for the OTC Derivatives Collateral Process (the 2013 Statement) and the other the 2014 Collateral Agreement Negative Interest Protocol (the 2014 Protocol). The 2013 Statement sets out that where interest rates are at a negative level, that negative rate should be used and the 2014 Protocol contemplates that parties will amend their CSA so that negative benchmark interest rates could ‘flow through ISDA collateral agreements’. The parties had not amended their CSA to reflect the 2014 Protocol.

DB however relied on the ISDA User’s Guide which sets out that the Transferor will pay interest to the Transferee and the opposite is not true.

What did the court decide?

Judge Knowles set out that the State did not demonstrate an obligation in respect of negative interest.

While the definition of ‘Interest Amount’ could allow for a negative figure as a matter of language, the agreement itself does not include such an obligation: if there were such an obligation, it would be spelled out. The parties did not set out within the CSA that it intended for the payments to be transferred by the bank if negative interest was to be paid. They had the opportunity to clarify this in Paragraph 11(f)(iii) of the CSA but they did not. In fact, in the CSA the parties confirmed that a zero interest rate should be used if the wrong account was used, but did not specify that in that situation the rate would be the better outcome of zero or a negative interest rate, which the judge thought they would have done, had negative interest been possible.

The judge also considered why commercial parties would only have been concerned by interest rates if they were positive but not negative. He argued that there were several reasons for this, including that the parties might have wanted a simple arrangement or that it might not have been their intention that although the Transferor should receive some benefit if it was holding the cash collateral, the converse might not necessarily be true in that the Transferor should shoulder the burden if the interest rate was negative.

The 2013 Statement and 2014 Protocol were not in existence when the agreements were entered into and so could not be considered as part of the agreement between them. The 2013 Statement expressly set out that they did not create legal obligations or affect existing arrangements. For the 2014 Protocol to be effective, an amendment by the parties should have been made to the CSA as expressly set out in the 2014 Protocol. The judge distinguished the ISDA User’s Guide from the 2013 Statement and 2014 Protocol, which is designed to assist with interpreting the ISDA documents.

Judge Knowles also confirmed Wood v Capital Insurance Services [2017] UKSC 24, which states that when interpreting the provisions of a commercial contract, the language should be looked at by the court and the commercial consequences investigated. He also confirmed the recent cases which have set out that an ISDA standard form master agreement should be interpreted in a way that is predictable so parties know where they stand and that when parties choose to use a standard form agreement, they do so with the intention that particular facts have a more limited role to play than in more bespoke arrangements. Judge Knowles did not think it would be appropriate to distinguish a CSA from an ISDA master agreement.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Case details

  • Court: Queen’s Bench Division, Commercial Court (Financial List)
  • Judge: Robin Knowles J
  • Date of judgment: 25 July 2018


Relevant Articles
Area of Interest