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15 May 2019

Interpreting ISDA: positive results on negative interest rates


A number of recent cases in the Court of Appeal and Commercial Court have examined the meaning of standard terms in ISDA contracts. The clear message is that ISDA documentation, insofar as possible, will be construed to mean just what it says. In the case of a potential liability for banks to pay negative interest, this means no such obligation will exist unless the parties have expressly agreed to it.

While the outcome of the appeal in The State of the Netherlands v Deutsche Bank is perhaps unsurprising, it is worth paying attention to the reasoning adopted by the court. Cases on the meaning of industry standard terms can have wide-ranging effects. This decision focussed on one specific issue (negative interest rates) but the Court's approach in this case to interpreting ISDA guidance statements is likely to have wider application.

Background to the State's claim

In early 2001, the parties entered into an ISDA Master Agreement and Credit Support Annex ("CSA"). The interest rate in the CSA was a low one (EONIA minus 4 basis points). In 2014, the interest rate fell below zero, where, for the most part, it then remained. The State argued that where the Interest Amount for any given period was negative, the Bank effectively had to pay "negative interest" to the State (by including negative unpaid interest in the calculation of the Credit Support Balance). The Bank disagreed and argued that it was never intended that "negative interest" would be paid. The contractual documentation itself made no reference to "negative interest", possibly because it was simply not contemplated as a possibility at the time. Put simply, at first instance, Mr Justice Knowles agreed with the Bank, stating that if payment of negative interest were a contractual obligation, it would have been spelled out: "the CSA does not contemplate a legal obligation to account for negative interest".

In particular, he examined the following provisions in the CSA:

  • A paragraph in the CSA provided that only the Bank was defined as the "Transferor" and only the State as "Transferee"
  • The interest obligation in the CSA stated that "the Transferee will transfer to the Transferor…the…Interest Amount"
  • The definition of "Credit Support Balance" provided that any: "Interest Amount…not transferred…will form part of the Credit Support Balance"

Mr Justice Knowles concluded that the only reference to interest was the payment of the Interest Amount by the State (the "Transferee"). He rejected the State's argument that the definition of the Credit Support Balance contemplated accounting for negative interest by the Bank to the State because: 1) it was not explicitly spelled out and; 2) there was no credible commercial rationale for the parties to have opted to deal with positive and negative interest in such significantly different ways.

The decision on appeal

On appeal, the Court concluded that Mr Justice Knowles had reached the right decision but by the wrong method. In finding for the Bank because of the lack of an explicit reference to the payment of negative interest, it concluded he had: "adopted too simplistic an approach". Going further, the Court of Appeal decided that in fact the language of the contractual documentation could, in theory, provide for the payment of negative interest.

In deciding that ultimately it did not bear that meaning, the Court of Appeal referred to these key issues:

  • The 2010 ISDA Best Practice Statement (a post-contractual document not put before the trial judge) provided that: "at no point should the interest accrual drop into a negative figure. If this occurs the rate should be floored at zero". The Court deemed this was relevant in showing: "ISDA's thinking" and could not be ignored in the question of interpretation.
  • Both sides argued that the contract could have explicitly clarified the position one way or another. The starting point on interpretation had to be, however, what the drafting did include, rather than what it did not.
  • A series of hypothetical "asymmetries", identified by Counsel for the Bank, if the State's interpretation were correct had significant force.
  • Looking at the contractual documentation as a whole, the Court concluded there was nothing to give: "the impression that negative interest was contemplated or intended".


The Court of Appeal's analysis was similar but different to the Commercial Court's. Rather than focussing on the absence of an express obligation to pay negative interest, it took more account of the overall context. On the question of methodology it followed the guidance from the Supreme Court in Wood v Capita, citing that: "where there are rival meanings, the court can give weight to the implications of rival constructions by reaching a view as to which construction is more consistent with business common sense."

The most interesting element of the analysis is the use made of ISDA guidance. Rarely is a post-contractual document permissible as an aid to interpretation. Here, it seems that precisely because the parties were using standardised ISDA documentation the Court was prepared to attach weight to the guidance provided by ISDA. In particular, it was influenced by the fact that the 1999 ISDA User's Guide (the pre-contractual guidance) made no reference to negative interest rates and that when the possibility of such a rate arose, ISDA provided guidance to the effect that it should be floored at zero instead of dropping into a negative figure.

While the Court's attention was drawn to the "Background" note to the 2014 ISDA Negative Interest Protocol (suggesting that from a commercial perspective, it was thought important that "negative benchmark rates" should in some circumstances flow through to ensure "economic consistency" in the derivatives market), this was not construed as meaning the CSA should be interpreted to account for negative interest. Rather, it was considered supportive of the fact that ISDA recognised that the standard terms of the CSA did not provide for the payment of negative interest.

More practically, the decision is of significance for endorsing the conclusion (albeit on different grounds) of the lower Court that, unless expressly provided otherwise, negative interest is not payable under the standard ISDA CSA.