1 5 Negative Interest Rates Practical consequences and legal issues Introduction Decision of the SNB Since January 22, 2015 the Swiss National Bank (the SNB) has imposed a negative interest rate of minus 0.75% p.a. on sight deposit account balances of banks that exceed a given threshold. The SNB took this measure after it ended its policy of setting the minimum exchange rate of EUR CHF 1.20 in order to deter demand for the Swiss franc. Charges on customer deposits As a consequence, a number of Swiss banks have in turn introduced interest charges for large customer deposits, particularly those of financial institutions, institutional investors and high net worth individuals. The introduction of negative interest for large customer deposits was further supported by regulatory developments in Switzerland that have made the acceptance of large customer deposits by Swiss banks less attractive. On the one hand, Switzerland has already implemented the Basel III framework for the liquidity coverage ratio, which requires Swiss banks to cover deposits of financial institutions and institutional investors with 100% high quality liquid assets. On the other hand, the requirements of the leverage ratio, with which Swiss systemically important financial institutions must already comply, incentivize banks to shrink their balance sheets. As a result, Swiss banks have become reluctant to accept deposits that cannot easily be used for refinancing purposes while increasing the balance sheet total. Further consequences In addition to the introduction of charges on deposits, the introduction of negative interest rates by the SNB has had further consequences, including the following: In January 2015, short-term interest rates, represented by the 3-month Swiss franc LI- BOR (the 3-month CHF-LIBOR), dropped below zero and have remained in the range of -0.5 to -1.0% p.a. ever since. This development has raised issues under credit agreements that use the 3-month CHF- LIBOR as the reference rate for calculating interest payments, as well as under interest rate swap agreements, where the party that I336794v2
2 5 normally has to pay the floating rate amount has instead become the recipient of those floating rate amounts. Non-Swiss banks holding large Swiss francdenominated deposits have tried to eschew negative interest rates by granting loans to Swiss cantons and other governmental institutions at negative interest rates that are lower than those charged on moneys deposited with Swiss banks. The negative interest rate environment has also reduced the yields on Swiss franc bonds. The yield on short-term bonds of the Swiss Confederation (Eidgenossen) has been negative since the beginning of 2015, and even the yield for the Swiss Confederation's 10-year bonds hovers around 0%. In contrast, we have not (yet) seen negative interest rates on mortgage and commercial loans by Swiss banks or on retail deposits with Swiss banks. Is negative interest still interest? The Swiss Code of Obligations (CO) does not define the term "interest". According to the Swiss Supreme Court and scholars, interest constitutes the consideration paid to the lender in return for providing the borrower with a loan. It is clear that negative interest does not fall under this definition of interest, given that it is the borrower who is receiving payment in such a situation rather than the lender. Therefore, negative interest rates must be understood as charges on the capital provided by the lender which are calculated on the basis of the amount of the capital and the duration of its allocation. Accordingly, in respect of negative interest rates imposed on deposits of foreign customers in certain periods of the 1960s and 1970s, the Swiss Federal Court held that they constituted commissions. While there has not yet been any judgment confirming this view in the current negative interest environment, we believe that the relevant analysis should be the same and negative interest should be qualified as a commission or charge rather than as interest. Legal permissibility of negative interest rates and their impacts Although Switzerland already experienced negative interest rates in the 1960s and 1970s, their legal permissibility and impacts is unclear. Since there is no provision prohibiting negative interest under the Swiss law on loans (article 312 et seq. CO) or otherwise, the parties are generally free to agree to such charges. However, the payment of negative interest (i.e., a commission) by the lender calls the fundamental structure of a fixed-term loan into question. Under the CO, the provision of capital is the lender's only primary duty, while the borrower is obliged to repay the nominal amount of the capital received plus interest (if any). Against this background the following seeks to shed some light on certain legal issues associated with negative interest rates in respect of three different types of financial products. Negative interest rates and bank deposits Customers who deposit money in a current account or savings account with a Swiss bank enter into a deposit agreement with the bank. It is quite controversial how such an agreement should be qualified under Swiss law. While the Swiss Federal Court once qualified a savings account as a contract of bailment (article 472 et seq. CO), certain scholars deem it to be a loan contract (article 312 et seq. CO). The decision of the Swiss Federal Court mentioned above concerned a savings account that was bearing (moderate) interest for the customer. Nevertheless, the Swiss Federal Court held that the customer's interest in safely depositing its moneys prevails over the bank's interest to finance itself. Therefore, if a bank imposes negative inter-
3 5 est on a customer's deposit, we believe that the deposit agreement between the bank and the customer would normally qualify as a contract of bailment rather than as a loan contract. If the deposit agreement is a contract of bailment, negative interest can be considered to be remuneration paid to the bailee (article 472 para. 2 CO). However, such remuneration may only be claimed by the bailee if it is customary or if there is a sufficient contractual basis. Consequently, in situations where negative interest is not customary, banks may charge the deposits of their customers only if there is a sufficient contractual basis in place. This can be achieved by inserting a clause into the general terms and conditions of the bank explicitly providing for negative interest. Alternatively, banks may be able to rely on provisions in their general terms and conditions that allow the bank to charge usual fees and commissions and or to adapt its fees and commissions to changing market conditions. However, under the general terms and conditions the introduction of negative interest charges may require prior notice (typically 30 days). Additionally, the introduction of negative interest on deposits of retail investors based on any such provisions may come under additional scrutiny under the rules on unusual and or unfair terms in standard contracts. Negative interest rates and credits In Switzerland, interest rates on commercial credits and mortgage loans are often calculated as the sum of a reference rate (e.g., 3-month CHF- LIBOR) and a certain margin (e.g., 1% p.a.). If the reference rate turns negative, it starts eating into the margin or, if sufficiently negative, results in an overall negative interest rate. calculating the interest rate, the reference rate will be set at 0% or, if higher, the applicable market rate. By doing this, the bank is able to protect the margin against negative reference rates. If a credit agreement does not contain such a floor and the reference rate used to calculate the interest rate drops below 0%, it is a matter of interpretation of the individual contract as to whether the reference rate is considered to be floored at 0% or whether the actual negative number should be used. Given that the margin is generally intended to compensate the bank for the risk and costs incurred with the credit, it should not easily be presumed that a fall in interest rates as a result of central bank interventions should deprive the lender bank of all or part of its margin or even oblige it to pay amounts to the borrower. A different interpretation may, however, be warranted if negative interest rates were already prevailing at the time the parties entered into the credit agreement or if the parties to the credit agreement agreed that the lender will in fact refinance itself one-to-one on the money market. Negative interest rates and bonds The issue of negative interest rates has also come up in the capital markets in connection with floating rate notes that have been issued with coupons tied to short term reference rates such as the 6-month CHF-LIBOR. As is the case for credit agreements, the wording of the terms of the notes and other relevant circumstances must be carefully analyzed to determine whether a negative reference rate should be used for purposes of determining the interest rate on the notes. However, the analysis under Swiss law is not necessarily identical, for the following reasons: In recent years, banks have started to introduce provisions in their commercial credit and mortgage credit agreements setting forth an explicit floor of 0% for the reference rate used to calculate the interest rate. This means that, for purposes of As opposed to a bank lender, the bondholder is normally not presumed to bear administrative cost, capital charges etc. on its bondholding. Therefore, it may be easier to argue
4 5 that a negative reference rate shall be deducted from the margin. However, like in the credit market, it would be unusual for the resulting interest rate to be negative and that, therefore, the bondholder would have to make coupon payments to the issuer. On the one hand, the terms of the notes typically provide for a payment obligation of the issuer only. On the other hand, the clearing and settlement systems are normally not equipped to collect coupons or interest amounts from the bondholders. Therefore, floating rate notes nowadays explicitly provide for a 0% floor for the reference rate. be the receiver of such payments under both legs. The same result applies for interest rate swaps documented under the 2013 Swiss Master Agreement for OTC Derivatives. In May, 2014 ISDA published the ISDA 2014 Collateral Agreement Negative Interest Protocol. It amends the "Interest Amount" section of ISDA's collateral agreements. If both parties to a swap transaction adhere to this protocol and the interest rate becomes negative, the party that was originally obliged to pay interest on cash collateral deposited now deducts amounts therefrom. Accordingly, under the protocol, negative interest will also be charged on cash amounts transferred under ISDA collateral agreements. Separate from the point of negative interest rates is the issue of negative yields in the capital markets. In fact, the yield on bonds and other financial instruments can be negative even if a coupon is paid. In particular, this occurs if a bond is issued or traded above par and the proceeds from coupons paid during the term of the bond are smaller than the premium. However, as long as a coupon is paid, a negative yield does normally not impact the legal analysis with respect to the coupons. Coupon payments are still interest, and the calculation of such interest is still made by reference to the nominal amount of the bond. Negative interest rates and interest swaps If a swap transaction incorporates the 2006 ISDA Definitions the parties may employ either the "Negative Interest Rate Method" or the "Zero Interest Rate Method". If the parties fail to choose a method, the "Negative Interest Rate Method" applies. This means that the fixed rate payer who would, under normal circumstances of a positive floating interest rate, receive a floating amount will become the payer of the floating amount in the case of a negative interest rate. Consequently, in such scenario, the fixed rate payer would pay under both legs of the swap, while the receiver would Impacts on taxation The Swiss tax authorities typically do not accept negative interest rates. For the calculation of the bond floor of a product with predominant one-time interest payment, the interest component will therefore be zero if the applicable interest would be a negative interest rate. The same is the case with respect to coupon split of reverse convertibles. Consequently, the interest component of a reverse convertible with a maturity of up to 5 years is currently zero and the whole coupon component is considered as tax-free capital gain. On the other hand, the minimum tax rate currently applied by the Swiss federal tax administration to intercompany loans denominated in CHF is still 25 bps. If intercompany balances (e.g., under a cash pool arrangement) is based on CHF-LIBOR rates (plus minus a margin of typically 25 or 50 bps), a clearance should be obtained from the Swiss tax authorities that the respective interest rate (which might be negative) is acceptable from a Swiss federal withholding tax perspective and or a corporate income tax perspective.
5 5 Benedikt Maurenbrecher Dr. iur., MBA, Attorney-at-Law benedikt.maurenbrecher@homburger.ch T +41 43 222 15 15 Stefan Oesterhelt lic. iur., LL.M., Attorney-at-Law, Certified Tax Expert stefan.oesterhelt@homburger. T +41 43 222 12 65 Daniel Haeberli lic. iur., LL.M., Attorney-at-Law daniel.haeberli@homburger.ch T +41 43 222 16 33 Jürg Frick Dr. iur., LL.M., Attorney-at-Law juerg.frick@homburger.ch T +41 43 222 15 16 Eduard De Zordi lic. iur., LL.M., Attorney-at-Law eduard.de_zordi@homburger.ch T +41 43 222 16 57 Lee Saladino J.D. lee.saladino@homburger.ch T +41 43 222 17 08 Practice Teams Financial Services Tax Homburger AG Prime Tower Hardstrasse 201 CH-8005 Zurich P.O. Box 314 CH-8037 Zurich T +41 43 222 10 00 F +41 43 222 15 00 lawyers@homburger.ch Legal Note This Homburger Bulletin expresses general views of the authors at the date of the Bulletin, without considering the facts and circumstances of any particular person or transaction. It does not constitute legal advice. As such, this Bulletin may not be relied upon by any person for any purpose, and any liability for the accuracy, correctness or fairness of the contents of this Homburger Bulletin is explicitly excluded.