The ISDA 2014 Collateral Agreement Negative Interest Protocol is so 2015

The ISDA 2014 Collateral Agreement Negative Interest Protocol (the “Protocol”) has received renewed attention recently, with ISDA hosting a Market Education Webinar to discuss the structure and content of the Protocol on 11 March 2015, followed by the publication of a Statement on Negative Interest Rates on 12 March 2015 and a Market Guidance concerning Interest Rates on Cash Collateral under ISDA Collateral Agreements on 13 March 2015.

The Protocol was published on 12 May 2014 and the number of adhering parties has been increasing at a steady pace since. As the negative interest climate settled in, more market participants came to notice the importance of an ambiguity in the vast majority of the collateral agreements in circulation.

The key issue is that the documentation does not address with sufficient clarity the question of negative interest in relation with the Interest Amount. The party receiving the collateral (the “Secured Party”, or otherwise identified) would not have an unequivocal right to request the payment of the negative interest, leaving it exposed to a recurring loss caused by a negative interest rate. As the current economic outlook may warrant the rates to remain negative, losses may be incurred until the rates swing back to positive or the Protocol is adhered to.

The Protocol goes a long way in ensuring that negative interest amounts produce an outcome similar to positive interest amounts. At the end of each month, where the interest rate is positive, the Secured Party transfers the full amount of the interest, and where the interest rate is negative, the Secured Party should be paid the absolute value of the negative interest by the party posting cash collateral (the “Pledgor” or otherwise identified).

The Protocol covers the vast majority of ISDA collateral agreements out there, namely:

• 1994 ISDA Credit Support Annex (New York law)
• 1995 ISDA Credit Support Annex (English law)
• 1995 ISDA Credit Support Deed (English law)
• 1995 ISDA Credit Support Annex (Japanese law)
• 2001 ISDA Margin Provisions
• 2008 ISDA Credit Support Annex (Loan/Japanese pledge)

The most recent ISDA collateral agreements, that is the 2014 Standard Credit Support Annex (Security Interest – New York law), the 2014 Standard Credit Support Annex (Transfer – English law) and the 2013 Standard Credit Support Annex (Security Interest – New York law) remain outside the scope of the Protocol as these versions already incorporate the necessary provisions to achieve a similar treatment for positive and negative interest amounts.

Nonetheless, the availability of these new standard collateral agreements is unlikely to obliterate the necessity of amending the legacy agreements en masse. The reason is that the legacy collateral agreements remain the most prevalent in the market.

Hence the interest of the Protocol, as it should permit the amendment of a significant number of collateral agreements by reason of its wide scope. It is fair to say that a Protocol has rarely dealt at the same time with so many versions of an agreement, featuring slightly different language and structure. This complexity is reflected by the use of six separate sections in the Protocol to catch each version of the collateral agreements, covering both standard language and certain minor amendments.

Despite the Protocol gaining momentum, not all market participants have adhered to the Protocol, while the agreements containing a Protocol Excluded Modifying Provision may demand further attention. The agreements with one of the six following amendments are automatically excluded:

• A Custodial Interest Provision, where cash collateral is held at a party custodian, as it generally involves that no interest is paid on the amounts held by such custodian
• an Interest Amount Alternative Provision, where the Interest Amount is calculated by reference to another financial indicator
• a Negative Interest Amount Provision, where the parties have already negotiated specific provisions to address the issue of negative interest
• a No Interest Provision, where the parties have agreed to exclude the payment of interest
• a Spread Provision, where the parties have agreed to a spread – a rate plus or minus a certain number of basis points
• a Unilateral Posting Provision, where only one party may be the Secured Party

In the case of a collateral agreement which falls outside the Protocol, ISDA suggests entering into a 2 page long Opt-In Agreement to bring it within its scope.

As an alternative, parties may wish to consider the opportunity to repaper the black sheep with the newer CSAs.

The pressure on collateral agreements is not likely to diminish in the coming months, as significant changes will be introduced via the upcoming regulations on margin of non-centrally-cleared from September 2016.  In this context, the negative interest issue serves as a loud wake-up call.

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