Seeking certainty in a negative interest environment

What do lawyers need to know about the International Swaps and Derivatives Association (ISDA) protocol governing collateral under negative interest environments? In a straightforward, insider’s take on what motivated the protocol and drove its creation, Nick Sawyer of ISDA explains its core values and the collateral arrangements to which it applies, while Mark Dwyer, a partner at Slaughter and May and head of the firm’s derivatives practice, offers a practitioner’s perspective.


Different approaches to how to deal with the issue of negative interest rates can leave to discrepancies between institutions in the market. Despite the amounts of money involved being comparatively small, the lack of consistency is seen as unwelcome, leaving ISDA to rectify the situation with a protocol to govern collateral under negative interest environments (see Press Release: ISDA publishes ISDA 2014 collateral agreement negative interest protocol).

What does the ISDA 2014 collateral agreement negative interest rate protocol do?

Nick Sawyer (NS): The protocol is designed to provide certainty about how the payment of interest on posted collateral is calculated in a negative interest rate environment under ISDA collateral documentation. Specifically, it makes clear that the party pledging cash collateral would pay interest to the collateral receiver in a negative interest rate environment by paying the absolute value of the applicable interest amount.

As originally drafted, ISDA collateral documentation omitted to specify how negative interest should be settled, leading to some difference of opinion in the market. The protocol allows adhering parties to modify certain collateral agreements to clarify the treatment for negative interest amounts on cash collateral. The protocol does not cover agreements that have been bilaterally negotiated to include:

  • a custodial interest provision
  • interest amount alternative provision
  • negative interest amount provision
  • no-interest provision
  • spread provision, or
  • unilateral posting provision

Mark Dwyer (MD): Parties to a derivative transaction governed by an ISDA Master Agreement and certain ISDA collateral documentation can, by signing up to the protocol, contractually agree how the payment of interest on posted cash collateral is to be calculated and paid in a negative interest rate situation. Such a situation can occur when rates are in negative territory or when interest is accruing on a spread below a low interest rate. The terms of the protocol create certainty over an issue that can sometimes be a point of ambiguity and dispute.

What collateral agreements can the protocol be applied to?

PSL practical point: The protocol applies to the:

  • 1994 ISDA credit support annex (CSA) (security interest–New York law)
  • 1995 ISDA CSA (transfer–English law)
  • 1995 ISDA credit support deed (security interest–English law)
  • 1995 ISDA CSA (security interest–Japanese law)
  • 2008 ISDA CSA (loan/Japanese pledge), or
  • 2001 ISDA margin provisions (in any case, an ‘ISDA collateral agreement’)

Where an ISDA collateral agreement has been secured by a third party, their consent must be acquired in order to bring that agreement under the terms of the protocol.

What is the effect of the protocol on an English law or New York law CSA?

NS: By signing up to the protocol, parties are agreeing an amendment to the terms of their ISDA collateral agreement to specify the consequence of a negative interest amount on cash collateral. The relevant collateral agreement must be covered by the terms of the protocol for the amendments to apply. It also must not contain any modifying provisions that the protocol deems exclude the operation of the protocol—if it does, and the parties want the protocol to apply, they will have to make bilateral arrangements to opt in to the protocol.

MD: In the case of the 1995 ISDA CSA governed by English law, if the specified interest rate is negative, leading to a negative interest amount on cash collateral for an interest period, then the terms of the protocol provide for the party posting collateral to pay the absolute value of that interest amount in respect of that interest period to the collateral receiver. This is the converse of what happens with positive interest amounts which are paid by the collateral received to the collateral taker.

The other terms in the collateral agreement (such as timing of the transfer of interest) are amended as necessary so that they operate in the same way as if the interest amount was a positive amount.

Although we don’t practice New York law, our understanding is that the particular amendments required to effect this arrangement for posting of collateral under the 1994 ISDA New York law CSA are different to the amendments required for the English law CSA as the collateral agreements themselves differ—the English law document allows for a full title transfer collateral arrangement and the New York law document provides for a security interest arrangement. Despite these differences, the effect of the changes appear to be similar—the New York law CSA allows for the pledgor to pay the absolute value of the negative interest amount to the secured party in respect of cash collateral pledged by the pledgor to the secured party for that interest period.

Why are there differing views as to how paragraph 5(c)(ii) of the CSA should be interpreted in light of negative interest?

MD: If parties have entered into a CSA according to its standard terms (ie unamended in relation to the way the interest amount is calculated and how it is transferred) then para 5(c)(ii) of the English law CSA only explicitly allows for the transfer of interest by the transferee (collateral receiver) to the transferor (collateral poster).

There is no express provision that the interest rate applicable to the interest amount is floored at 0% such that only positive interest amounts will ever be transferred. However, an implied floor of 0% can be argued because there is no express right of the collateral receiver to receive interest from the collateral poster.

As there is no express floor of 0%, some parties have argued that it is logical and implied that negative interest amounts should be transferred (in an amount equal to the absolute value). Those arguing that position say it goes without saying that the relevant party transferring interest in such a situation is the collateral poster (despite the standard terms of the CSA). However, any such obligation to transfer negative interest amounts under a standard CSA is not apparent from the face of the document and would appear to strain the wording of the document to argue that such an obligation is implied.

In light of the ambiguity and difference of opinion among market participants, the safe approach is to agree bilaterally a floor if parties want negative interest amounts to be disregarded and if parties want negative interest amounts to be passed on parties might either agree to this bilaterally in the contract or sign up to the terms of the protocol.

Interviewed by Julian Sayarer.

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

First published on LexisPSL Banking & Finance. Click here for a free trial.

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