IRS derivatives: the latest case law of January – March 2021 in Italy
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A substantial “draw” between nullity and validity.
In our publication of 16 December 2020, we gave an overview of Italian case law in 2020 on the nullity of Interest Rate Swap (IRS) contracts: the majority of the decisions published at that time declared such contracts null and void in the absence of certain requirements.
In the first quarter of 2021, Italian Courts issued several decisions on IRS contracts. Some Courts ruled that IRS contracts were null and void due to lack of causa or object, confirming, albeit with different nuances, the opinion by the Italian Court of Cassation in the well-known Decision of the Joint Divisions of 12 May 2020, no. 8770. At the same time, other Courts ruled that the derivative contracts in question were valid, setting out different principles from those expressed by the Joint Divisions of the Italian Court of Cassation.
The decisions either following the opinion on the validity or the one on the nullity of IRS contracts seem equally split: this confirms the existence of contrasting views among Italian Courts on the validity of IRS contracts.
The rulings that declared the nullity
An analysis of the merit rulings of the first quarter of 2021 indicates that at least nine decisions declared the nullity of IRS contracts:
- Tribunal of Cosenza 13 December 2020;
- Court of Appeal of Ancona 14 January 2021, no. 24;
- Tribunal of Parma 15 January 2021, no. 44;
- Tribunal of Forlì 27 January 2021;
- Tribunal of Turin 1 February 2021, no. 293;
- Tribunal of Rome 8 February 2021;
- Court of Appeal of Milan 3 February 2021;
- Court of Appeal of Turin, 11 March 2021 no. 277; and
- Tribunal of Genoa 25 March 2021, no. 698.
In particular, we highlight the following:
- Tribunal of Cosenza 13 December 2020.
In this ruling, the Court expressly stated that it “followed the opinion lastly embodied in the decision of the Joint Divisions”, and declared the nullity of an IRS contract for the lack of “indication of the method of calculation of the Mark to Market”, as well as for the lack of information on “the probabilistic scenarios”;
- Court of Appeal of Ancona 14 January 2021, no. 24.
In this ruling, the Court of Appeal upheld the first instance decision – which had declared an IRS contract null and void for lack of causa. In particular, the Court stated that: “The swap contract, following the opinion set out by the Joint Divisions, achieves interests that deserve protection and is therefore protected by the legal system, to the extent that it determines reciprocal and bilateral risks, the quality and quantity of which are known and measurable by the parties [through the probabilistic scenarios and the information on the Mark to Market]”.
The rulings that declared the validity
On the contrary, at least nine other merit rulings opted for the validity of IRS contracts:
- Tribunal of Vicenza 9 December 2020, no. 2177.
- Tribunal of Bologna 19 December 2020;
- Tribunal of Parma 4 January 2021, no. 10;
- Tribunal of Bologna 5 January 2021, no. 10;
- Tribunal of Verona 11 January 2021;
- Tribunal of Rome 17 February 2021, no. 2889;
- Tribunal of Parma 8 February 2021, no. 293;
- Tribunal of Verona 8 February 2021; and
- Tribunal of Milan 22 March 2021, no. 2399.
The following rulings are particularly important:
- Tribunal of Bologna 5 January 2021, no. 10.
Firstly, this decision acknowledges that the opinion of the Court of Appeal of Milan of 18 September 2013, no. 3459 (a leading case in declaring the nullity of IRS contracts) is to be considered “now dated”; the Court therefore affirms the non-essentiality, for the integration of the requirement of the causa, of the information on: (i) the initial Mark to Market; (ii) the mathematical pricing model; and (iii) the probabilistic scenarios as “the causa of derivatives is the exchange, at fixed maturities, of the values of the underlying, determined on the basis of the conventional value of the underlying on a certain date and of the different value that the same underlying assumes on the date of execution”;
- Tribunal of Parma, 8 February 2021, no. 293.
In this ruling, the Court stated that the principles outlined by the Joint Divisions of the Italian Supreme Court of 2020 would be applicable only to contracts entered into with public authorities (enti pubblici) in order not to compromise the rules of public accounting. The Court therefore excluded that in contractual relationships between private parties the Mark to Market could be considered an essential element of the contract (in particular its object) since such element “encodes the result (precisely, the economic value) of the risk assumed by the client […]”, being merely the “final outcome of a complex calculation operation”;
- Tribunal of Verona 11 January 2021.
In this ruling, the Court, while holding applicable the principles expressed by the Joint Divisions of the Italian Supreme Court of 2020, rejected the request for nullity of a series of IRS contracts. In particular, the Court stated that IRS contracts always assume a negative value (not par) for the client (and positive for the dealer). In fact, the entity of this value – according to the Court – depends on a number of factors, including, inter alia: - the cost of hedging; - the premiums for operational risk and credit risk; and, - the profit margin to remunerate the capital invested.
A brief overview on probabilistic scenarios
The Joint Divisions of 12 May 2020 decided that a derivative contract must be voided if it did not indicate, at the time it is signed, the “probabilistic scenarios”. The Italian Court of Cassation did not explain this requirement.
The other Courts have also not clearly specified what “probabilistic scenarios” mean. Among the analysed rulings, only two give some insight into this notion. In particular, it appears that probabilistic scenarios have been identified as:
- the “trend of Euribor 6 month rates (forward rates curves)” (see Tribunal of Forlì 27 January 2021); or
- the forecasts of the “Bulletin of the European Central Bank [...] and the forward rates calculated on the basis of the Euri[r]s rates [...]” (see Tribunal of Turin 1 February 2021, no. 456, although in that case the scenarios were taken into account to assess the actual existence, or not, of a bilateral risk).
On “probabilistic scenarios”, prominent scholars have strongly criticised this obligation to provide information created by case law, due to its vagueness and indefiniteness, and has also challenged the assumption that “probabilistic scenarios” have a scientifically and objectively agreed value.
Lastly, for the sake of completeness, it should be noted that probabilistic scenarios can be distinguished from the “performance scenarios” set forth by: (i) Article 48 of Regulation (EU) 2017/565, referred to in Article 36 of Intermediaries Regulation 20307/2018; and (ii) the rules on the so-called PRIIPS. The latter scenarios, in fact, unlike the probabilistic scenarios, do not measure the probability of occurrence of a given event but rather suggest, by way of simulation, what could happen in the presence of a given event capable of having distorting effects on the market (the so-called “what if”).