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Effects of Negative Interest Rates on Floating Rate Loans and Bonds Analysis of Legal and Financial Profiles

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Quaderni giuridici (Legal research papers) Effects of negative interest rates on floating rate loans and bonds Analysis of legal and financial profiles S. Alvaro, A. Gentili, C. Mottura 14 November 2017 L’attività di ricerca e analisi della Consob intende promuovere la riflessione e stimolare il dibattito su temi relativi all’economia e alla regolamentazione del sistema finanziario. I Quaderni di finanza accolgono lavori di ricerca volti a contribuire al dibattito accade- mico su questioni di economia e finanza. Le opinioni espresse nei lavori sono attribuibili esclusivamente agli autori e non rappresentano posizioni ufficiali della Consob, né impe- gnano in alcun modo la responsabilità dell’Istituto. Nel citare i lavori della collana, non è pertanto corretto attribuire le argomentazioni ivi espresse alla Consob o ai suoi Vertici. I Discussion papers ospitano analisi di carattere generale sulle dinamiche del sistema finanziario rilevanti per l’attività istituzionale. I Quaderni giuridici accolgono lavori di ricerca volti a contribuire al dibattito accademi- co su questioni di diritto. Le opinioni espresse nei lavori sono attribuibili esclusivamente agli autori e non rappresentano posizioni ufficiali della Consob, né impegnano in alcun modo la responsabilità dell’Istituto. Nel citare i lavori della collana, non è pertanto corret- to attribuire le argomentazioni ivi espresse alla Consob o ai suoi Vertici. I Position papers, curati dalla Consob anche in collaborazione con altre istituzioni, illustrano ipotesi di modifiche del quadro regolamentare o degli approcci di vigilanza e ricognizioni di aspetti applicativi della normativa vigente. Comitato di Redazione Simone Alvaro (coordinatore), Doina D’Eramo, Giorgio Gasparri, Giovanni Mollo Segreteria di Redazione Eugenia Della Libera, Walter Palmeri, Fabio Vasselli Progetto Grafico Studio Ruggieri Poggi Stampa e allestimento Marchesi Grafiche Editoriali Spa (Roma) www.marchesigrafiche.it Consob 00198 Roma – Via G.B. Martini, 3 t 06.8477.1 f 06.8477612 e [email protected] ISSN 2281-5236 (online) Effects of negative interest rates on floating rate loans and bonds Analysis of legal and financial profiles S. Alvaro*, A. Gentili**, C. Mottura*** Abstract and main conclusions The work analyses the legal and financial effects of negative money market in- terest rates on floating rate loans and bonds. The analysis is developed around finance, private law and regulation. The study is divided into four subject blocks. The first block considers the motives and objectives of the study, including the contextual elements surrounding the effects of sign of the interest rate within the logic of financial trade and specific elements surrounding the contracts under analysis. There are a further three parts. The first part analyses the legal foundations of the monetary policy choices of the European Central Bank (ECB) that led to the negative values of short-term interest rates, including with reference to the effects that these choices could have on the principle, protected in Italy by Art. 47 of the Constitution, of promoting citizens’ capaci- ty to save for investment purposes. The conclusion reached is that, at least in the short term, the monetary policy of the ECB (implemented under the powers awarded to it by European Treaties) indeed has the effect (albeit indirect) of protecting investors, inas- much as, by preserving the value of the monetary meter, it protects the economic system as a whole. This approach to the problem, alert to the profiles of constitutional protection of the founding principles of the different Member States and to the limits of accountability met by the ECB, is also found in recent case law of the Constitutional Court of certain Eurozone countries and of the European Court of Justice, as well as in widespread European doctrine. JEL Classifications: G10, G18, K12, K20, K22. Keywords: floating rate loans, floating rate bonds, negative interest rates, financial markets. * Head of Legal Studies Office, Consob Research Department. ** Full Professor of Private Law Institutions, Roma Tre University. *** Full Professor of Financial Mathematics, Roma Tre University. The opinions expressed in this Quaderno are exclusively of the authors and do not necessarily reflect those of Consob. Any mistake remains, of course, our sole responsibility. The second part of the study analyses the capacity of the national legal system to adapt to a context of negative rates. The study rests on the consideration that the Italian legal system (in which there is an abundance of provisions of the theme of inter- est) is lacking both an express unitary legal principle and a consistent concept on which to base the function of interest and in the light of which to set out the solution in new and unforeseen situations, such as negative rates. This shortcoming prevents legal experts from connecting new case law to a principle established by existing law, forcing them instead to expand the logic of the law, looking beyond the code, which for some time has failed to express the logic of the system. Thus, the different views on the effects of negative interest rates are analysed in the loan contract analysis, understood to be a paradigm of the credit contract category, to which even corporate bond regulations refer in some way. The third part questions more explicitly the existence in our legal system of im- passable legal and/or conceptual limits that prevent the use of negative interest rates. The study concludes that there are no conceptual and legal limits that prevent the use of negative interest rates in loan agreements. In terms of contract classification, we can discuss whether it is a legally or socially typical contract with the addition of a reason- based (indexing) clause (reasons that do not, in any case, alter the consideration), or whether instead it is an irregular contract, established in practice. But there shall be no doubt that the first case involves the inclusion of a legitimate clause and the second case involves the drafting of an irregular contract worthy of protection, in which the indexing introduces an element of lawful uncertainty to the relationship. Given that there are no legal constraints to the use of negative interest rates, the study then discusses the validity of the clauses deriving from private trading autonomy that limit the expenses borne by the creditors in the case of negative rates, such as, in particular, the so-called floor clauses, widely used in floating rate loans and bonds; a question raised in abstract by doctrine. Having argued that the recourse to floor clauses is not, in itself, in question, the study then tackles the question most often raised in the loan agreements that have been most heavily focused on in doctrine, i.e. the question of the need to comply with obligations of transparency and of balance between benefits (so-called bilateral balance), for the purposes of the validity of the floor clauses. The conclusion is reached that floor clauses are legitimate if formulated in a clear and com- prehensive manner and if adequately highlighted and that they do not in any way dam- age any alleged bilateral “balance” between benefits. This is because the fact that there is negative interest rate does not alter the nature of the loan, which is and remains primari- ly a contract for the ‘loan’ of a sum of money in which the payment of interest is not a part of the case law and in which the consideration is “variable”. Quaderni giuridici No. 14 4 November 2017 The study highlights the fact that, whereas in the banking field, the theme of negative interest rates is of central importance both to guarantee transparency of con- tract terms to customers (and therefore for the purpose of acquiring informed consent) and to ensure competition between brokers, in the financial field, the theme of negative interest rates also takes on particular significance for the purpose of guaranteeing the comparability of contract interest offered by the floating rate products, as well as com- pliance by brokers with adequate organisational and conduct regulations in the product distribution stage. In conclusion, the economic public order of direction here has nothing to say about the possibility of interest rates becoming negative. Indeed, it may see it as a possi- ble additional (reflected and desired) effect of the economic policy reasons that persuad- ed central banks to trigger the phenomenon. The question remains entirely down to the choices of private autonomy, even if the economic public order of protection requires, here as elsewhere in contract negotiation by non-professional operators, limits of trans- parency and information sufficient to guarantee informed and rational contractual decisions. Effects of negative interest rates on 5 floating rate loans and bonds Analysis of legal and financial profiles Contents Reasons, objective, contextual and specific elements 7 1 Study motivations and objective 7 2 Specific elements relating to the contracts under analysis 12 3 Negative rates and the monetary policy of the ECB 17 PART ONE Legal profiles relating to EU monetary policy within a context of negative rates 20 4 On the legal significance of monetary policy on interest rates in the EU 20 5 Investor protection profiles 21 PART TWO Views on the effects of negative interest rates on a contract 25 6 Market and legal regulations in the conformation of loan agreements 25 7 Interest rates in the Italian Civil Code 26 8 The different legal views on the effects of negative
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