In recent years, there have been numerous cases in the English courts between Italian municipalities and banks involving interest rate swaps.

Typically, these have involved local authorities in Italy seeking finance and entering into ISDA-governed interest rate swaps which have turned out unfavourably for the authorities.

The authorities have then issued proceedings against the banks for mis-selling unsuitable swaps and have claimed that since public authorities are not allowed to enter into speculative investments, the swaps are invalid under Italian law. The relevant banks have usually then sought to dismiss the claims against them on the grounds that the swaps are governed not by Italian law but by English law and that jurisdiction for deciding the matter lies with the English courts.

Until recently, most of the English court decisions have sided with the banks and decided that English courts have had jurisdiction to decide on the validity of the swaps entered into (see for example, TRM v BNP ).  However, since the decision of the Italian Supreme Court in 2020 in the case of Banca Nazionale del Lavoro SpA v Comune di Cattolica, the English courts have had to take into account the decided view of the Italian courts that swaps may in certain circumstances be void under Italian law.

The Cattolica decision

In the Cattolica case, the Italian Supreme Court held that certain interest rate swaps entered into by Italian local authorities were void as a matter of Italian law.

It was decided that Italian public authorities do not have capacity to enter into derivative transactions that (i) do not disclose the mark-to-market, probabilistic scenarios and hidden costs of the derivative (“Disclosure Test”) and (ii) are ‘speculative’ rather than for the purposes of ‘hedging’ (“Speculative Test”).

Further, derivative transactions that either: (i) provided for an upfront payment and/or (ii) extinguished or modified existing loans, constituted indebtedness which violated certain Italian laws and regulations (including Article 119 of the Italian Constitution) (“Indebtedness Test”); therefore, such transactions would require certain approvals to be considered valid.

English Court decisions post-Cattolica

Since the Cattolica decision, this issue has been considered a number of times by the English courts.

First, in Deutsche Bank v Busto di Arsizio (October 2021) (“Busto”), Deutsche Bank sought declarations that (i) Busto di Arsizio had capacity and authority to enter into the swaps and (ii) the swaps were valid and binding. Busto di Arsizio submitted a defence that (i) it did not have capacity to enter into the swaps as they were speculative and did not disclose the mark-to market, probabilistic scenarios and hidden costs, and that (ii) it needed City Council approval to enter into derivative contracts such as these swaps.

The English Court granted the declarations sought by Deutsche Bank, having considered Catollica as follows:

– The Disclosure Test was not applicable, as the swap contracts were governed by English law and as such any disclosure requirements in relation to those contracts were a matter of English and not Italian law. In any event, on the facts, sufficient disclosure had been provided by the bank so that Busto di Arsizio was able to make an informed decision when entering into the swaps.
– The Speculative Test was applied but not made out. The swaps in question were a common form of hedging and were entered into in order to reduce Busto di Arsizio’s risk of fluctuating interest rates, therefore the transactions were not speculative.
– The Indebtedness Test was applied but not made out. The swaps did not incur additional expenditure commitments or substantially modify Busto di Arsizio’s existing borrowing; therefore, the swaps did not constitute indebtedness (and so did not trigger any need for approval under Italian law).
– Busto di Arsizio therefore had capacity to enter into the swaps and did not otherwise require approval under Italian law in order to do so.

The Arsizio case was then followed by Dexia Crediop SPA v Provincia Di Pesaro E Urbino [2022] EWHC 2410 (Comm) (“Urbino”) which again confirmed that ISDA swaps entered into were valid under English law.

However, in Banca Intesa Sanpaolo SPA v Comune di Venezia [2022] EWHC 2586 (Comm) (“Venezia”), the English court held that the swap was invalid under English law owing to its invalidity under Italian law.

Why was a different decision reached in Venezia?

One of the key elements was the factual matrix underlying the swap. Comune di Venezia (“CDV”) had previously entered into a swap with Bear Stearns, which had a significant negative mark-to-market from the perspective of CDV (the “Original Swap”). CDV then entered into a new swap with Banca Intesa to replace its swap with Bear Stearns (the “New Swap”). The New Swap was structured so that the banks bore the unwind costs payable by CDV for exiting the Original Swap, with the price of the New Swap adjusted to account for this. Applying the decision in Cattolica, the English court held:

– Speculative Test: Because the New Swap price had been adjusted to account of the winding up costs of the Original Swap, it diverged significantly from the prevailing market rate. It was therefore speculative.
– Indebtedness Test: Banca Intesa paying EUR 8 million to Bear Stearns was an upfront loan, and therefore amounted to indebtedness.

As a result of the above, the English Court found that CDV lacked capacity to enter into the New Swap and had not obtained the requisite approvals pursuant to Italian law. The New Swap was therefore void and CDV was entitled to restitution of all sums it had paid to Banca Intesa pursuant to the New Swap.

This decision has now been appealed and a decision of the Court of Appeal is awaited.

Commentary

The English Courts have been consistent in determining that where the ISDA Master Agreement states it is to be governed and construed in accordance with English law, it will be English law which governs those contracts (and the resulting swaps).

However, the English Courts have accepted and applied the decision in Cattolica that Italian local authorities do not have capacity to enter into speculative derivative contracts – with the Speculative Test having been applied in all three cases. The English Courts have also been fairly consistent in their application of the Indebtedness Test as set out in Catollina.

The outcome of the Speculative Test and Indebtedness Test is very fact specific, as highlighted by the contrast between Busto and Venezia.

What’s next?

In the Venezia case, the Bank has appealed the finding that the interest rate swaps were void and that CDV’s restitution claim is not time-barred, whilst CDV has appealed the finding that the restitution claim was governed by English law and is subject to a change of position defence.

The Court of Appeal decision in Venezia is eagerly anticipated to provide guidance to the English courts in how to deal with existing and future Italian swap claims.

For more information, please visit our Banking & Financial Disputes Lawyers page.