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Bank must disclose initial negative market value of swaps in two-party scenarios

Federal Court of Justice, judgment dated 28 April 2015, file no. XI ZR 378/13

Following its decision in January this year,1 the German Federal Court of Justice (Bundesgerichtshof or BGH) has handed down another important judgment on banks’ obligations in swap transactions. The BGH held that, in a two-party scenario, banks must normally disclose the specific amount of a swap’s initial negative market value, irrespective of the swap’s complexity. Applying and extending the principles of its landmark decision in March 2011, the BGH stated that a bank typically has a severe conflict of interest if it recommends a swap transaction with an initial negative market value and enters into it with a client. A client would not expect the bank to profit by reselling its position and would instead assume that profits would come from the relevant interest rate movement only. On a positive note for banks, the BGH found that a swap transaction entered into by a municipality was valid, even if the swap’s purpose was speculative. The BGH also hinted at how a bank may disprove causation, and clarified some limitation issues.

Background: Implied duty to advise

German law requires banks to provide comprehensive information to clients about the opportunities and risks of a potential investment. This duty is usually based on a “tacitly concluded” advisory agreement. A bank is deemed to conclude such an agreement every time it presents specific investment opportunities to an investor. The BGH held that a bank may be obliged to disclose the initial negative market value of a swap because this reflects a severe conflict of interest for the bank. This was the key message from the court’s first ruling on banks’ disclosure obligations in relation to swaps in March 2011 (“Ille”)2. Since then, many companies, individuals and municipalities have lodged claims for damages against banks in connection with losses incurred in swap transactions. Several appeal courts considered whether the BGH’s findings were applicable to cases involving a variety of swap transactions, reaching inconsistent conclusions.3

No disclosure obligation where same bank is not advising and transacting

In January 2015 the BGH held that a bank is not obliged to disclose a negative initial market value of the swap in a three-party scenario. This is when a bank advises a client, and the client then enters a swap transaction with a different bank. In these cases, no conflict of interest arises and therefore an initial negative market value typically does not have to be disclosed. The court clarified that an initial negative market value of a swap is not an essential characteristic of the product which the client needs to be made aware of. In particular, the court considered that the market value would not normally reflect the client’s chances of success. The amount of the initial negative market value merely indicates the payment required by the client if he were to withdraw from the contract at that point. The court concluded in January 2015 that in the absence of a conflict of interest, a bank may recommend entering into a swap transaction without having to disclose a negative initial market value. A duty to disclose the initial negative market value existed in three-party scenarios only if the client’s chances of success, and thereby the value of the entire transaction, is disproportionately negatively affected by extensive cost and profit elements.

Facts of the case: Municipality dispute

The claimant in the current case is a municipality in North Rhine-Westphalia that had entered into several interest rate swap transactions with the defendant, a formerly state-owned Landesbank under a standard German Master Agreement for Financial Derivatives. The individual trades were of varying complexity. Each of the swaps had an initial negative market value.

The claimant made a loss on four of the swaps and (higher) profits on other swaps under the same master agreement. The profitable trades were not the subject matter of the proceedings. The bank insisted, however, that any losses from the swaps in dispute had to be set off against the profits made from the other swap transactions. The claimant stopped making on-going payments in 2011 and sued the bank for a refund of all payments made and a declaratory judgment that it did not owe any further payments. The defendant bank lodged a counterclaim for payment. The Düsseldorf Higher Regional Court, on appeal, issued the requested declaratory judgment and dismissed the parties’ claims for refund and further payment, respectively. The appeal court found that the bank had breached its duties under the advisory agreement by failing to disclose the initial negative market value of the swaps.

BGH decision: If same bank advises and transacts – duty to disclose

The BGH referred the case back to the appeal court as it required further fact-finding on several points. The judgment set out general principles and gave directions to be considered by the appeal court. Most importantly, the BGH held that in a two-party scenario, a bank that provides advice to its client and enters into the swap transaction must normally disclose the swap’s initial negative market value. The court understands this as the sum of the profit and cost components structured into a swap transaction, ie the bank’s gross margin. The BGH referred to its leading decision in 2011. Several appeal courts had limited the disclosure obligation solely to highly complex swaps, such as the “CMS spread ladder swap” that was at stake then. The BGH now has ruled that a bank must disclose the initial negative market value irrespective of the complexity of the swap transaction. The BGH perceived a severe conflict of interest and held that it did not depend on the swap’s complexity. The court considered that clients would not realise that a bank structures a negative initial market value into a swap in order to make a profit by selling the risk shortly after the transaction with the client. The BGH found that clients assume that a bank would profit from interest rate movements only.

The BGH also emphasised that a bank must specify the amount of the negative initial market value. In the court’s view, clients require this information to properly assess the bank’s interest in recommending the product.

Exceptions to duty to disclose

The decision acknowledged two exceptions to the duty to disclose the initial negative market value:

  • Swaps for hedging purposes – there is no duty to disclose the initial negative market value if the sole motivation for an interest rate swap is to hedge risks arising from a corresponding loan agreement with flexible interest rates. This exception also extends to cases where the risk resulting from the loan is only hedged partially. 
  • Three-party situations – there is also no duty to disclose because there is no conflict of interest in a three-party scenario where the advising bank and the bank selling the swap are not identical. 

Further points

The BGH made some further important observations:

  • The swap transactions were valid agreements, irrespective of whether the municipality had entered into them for speculative purposes only. These transactions were not ultra vires as municipalities may autonomously manage their assets. Nor did applicable public law of North Rhine-Westphalia prohibit speculative transactions.
  • A tacit investment advisory agreement only exists when a client asks the bank for ideas for investments and the bank then gives advice in the specific instance. A bank typically has no on-going obligation to advise the client on further investment decisions. The BGH complained that the appeal court failed to establish an advisory agreement for each swap in dispute, and wrongly relied on a overarching permanent advisory agreement it assumed had been tacitly concluded. The BGH held, however, that a permanent advisory agreement would have needed to be made expressly and, in particular, that the master agreement between the parties did not give rise to any such on-going duties.
  • The BGH further held that a bank may rebut the presumption of causation of damage by proving that a client would have entered into the transaction even if the client had known the existence and amount of the negative market value. The bank does not, however, need to disprove that the client made its investment decision dependent on market expectations. The BGH suggests two ways that a bank may disprove causation, referring to earlier decisions on other types of investment:
    • If a client knew that a bank added a gross margin into the swap’s conditions, this may suggest that the client would have entered into the transaction even if it had also known the amount of the gross margin.
    • The fact that a client wants to preserve other (profit-making) swap transactions where he/she was unaware of the initial market value may indicate that the non-disclosure did not cause the investment decision. This requires a scenario in which: (1) the initial negative market value would have needed to have been disclosed in all transactions; and (2) the client did not immediately request to unwind all transactions (including the profitable ones) when it became aware of this.
  • The limitation period for claims under each individual swap transaction runs separately. Even though the same disclosure obligation may have existed for all swaps, the BGH considered that it arose independently for each trade; there was no on-going breach. The Master Agreement bundles the various trades only for the purpose of close-out netting in an insolvency scenario. The court held that it has no relevance for damages claims.
  • For similar reasons, a claim for damages based on one swap transaction is typically not affected by profits derived from other swap transactions under the same master agreement. Thus, profits and losses from different transactions under the same master agreement can normally not be set off against each other. 


The judgment attracted considerable attention in Germany, both amongst legal commentators and in the press, as it was the first case decided by the BGH that involved a municipality. Several commentators had previously argued that public entities could not enter into any valid swap transactions other than for hedging purposes. Many had argued these transactions were either ultra vires or violated public laws. Now the BGH has confirmed that the swap transactions were valid agreements, irrespective of whether the municipality had entered into them for speculative or hedging purposes.

Banks will also welcome the confirmation that a permanent advisory agreement cannot arise tacitly. Instead, on-going advisory obligations can only be based on an express agreement.

However, the BGH took the view that a severe conflict of interest exists irrespective of the complexity of a particular swap. Therefore, the obligation to disclose the initial negative market value in two-party scenarios appears to extend to all swap transactions, except for those that exclusively have a hedging purpose. This is contrary to what many commentators had predicted. The decision therefore puts an end to the hopes that the “Ille” case from 2011 was based on the particular circumstances of that case, particularly the fairly complex structure of the so-called CMS spread ladder swap that was underlying the decision.

It appears now that there are only two scenarios where a bank does not need to disclose the initial negative market value of a swap transaction. One is a swap for the purpose of hedging risks of a corresponding loan agreement. The other is a three-party situation in which one bank advises the client and another enters into the swap transaction. Outside of these exceptions, banks defending such claims will have to focus on challenging the existence of an advisory agreement, disproving causation and the defence of statutory limitation.


1. Judgment dated 20 January 2015, file no. XI ZR 316/13; see article “German Federal Court of Justice limits banks’ disclosure obligations for swap transactions”, EFLR March 2015.
2. Judgment dated 22 March 2011, file no. XI ZR 33/10, see article “German Federal Court of Justice (BGH) renders opaque judgment in misselling case regarding interest rate swaps”, EFLR May 2011.
See article “Disclosure obligations and swaps: An analysis of regional variations in Germany”, EFLR February 2014. The BGH’s latest decision was given in the case before the Düsseldorf Higher Regional Court mentioned in that article.

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