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 interest 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' capacity 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, inasmuch 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.
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 interest) 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 impassable 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 damage 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 primarily 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".
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 contract 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 compliance 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 possible additional (reflected and desired) effect of the economic policy reasons that persuaded 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 transparency and information sufficient to guarantee informed and rational contractual decisions.  
 

Authors:
Simone Alvaro - Head of Legal Studies Office, Research Department, Consob (s.alvaro@consob.it)
Aurelio Gentili - Full Professor of Private Law Institutions, Roma Tre University (aurelio.gentili@uniroma3.it)
Carlo Mottura - Full Professor of Financial Mathematics, Roma Tre University (carlo.mottura@uniroma3.it)

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.

JEL Classifications: G10, G18, K12, K20, K22.

ISSN 2281-5236 [online]