This content is from: Structured Finance & Securitisation

The curious case of swaps with supranationals

When entering in to swaps with an international organisation, what do you need to think about to sleep easy? Hogan Lovells’ James Doyle and Oliver West have the answers

When entering in to swaps with an international organisation, what do you need to think about to sleep easy? Hogan Lovells’ James Doyle and Oliver West have the answers

There are a significant number of development banks, supra-national organisations and other entities established by international treaty which enter into over-the-counter (OTC) derivative transactions. For parties proposing to enter into OTC derivative transactions with entities of this type (referred to as international organisations), there are some key considerations to take into account. These are, of course, in addition to the usual legal, credit and tax issues that would be considered as a matter of course before transacting with any counterparty.

Capacity

The frequency with which the English courts have been called upon to consider an entity's capacity to enter into a derivative transaction is indicative of the importance of this issue. Particularly detailed analysis is often required in relation to the question of the capacity of international organisations. For the purposes of English law, the question is essentially two-fold: first, does the international organisation have legal personality, and second, does it have sufficient capacity to enter into derivative transactions of the proposed type?

Legal personality and capacity

The first question is important because English courts generally do not have jurisdiction to enforce rights and obligations that arise pursuant to international treaties. As such, an English court cannot recognise an international organisation as having legal personality – meaning the ability to sue and be sued before the court – where that legal personality is said to be derived from treaty alone.

The legal personality of certain international organisations is recognised for the purposes of English law by virtue of the International Organisations Act 1968 (Act) which provides for the 'legal capacities of a body corporate' to be conferred on organisations by the Crown by Order in Council. A number of organisations including, for example, the African Development Bank, have been conferred with legal personality in this manner.

However, many international organisations have not been conferred with legal personality pursuant to the Act. An English court may recognise the status of any such international organisation if it has been incorporated by at least one foreign state, provided that the state of incorporation is itself recognised by the Crown (Arab Monetary Fund v Hashim and Others [1991]). It may be expected that the state in which an international organisation has its headquarters will recognise the organisation as having legal personality, but this cannot be assumed and local law advice should be sought.

Capacity to undertake specific transactions

Similarly, it cannot be taken for granted that an international organisation which would be recognised by an English court as having legal personality necessarily has the capacity to enter into OTC derivative transactions, or at least OTC derivative transactions of all kinds. The capacity of an international organisation is a question of its constitution and public international law (Westland Helicopters Ltd v Arab Organisation for Industrialisation [1995]). It is not necessarily the case that an international organisation's capacity is equivalent to the capacity of a corporation in the state in which the relevant organisation is recognised as having legal personality for the purposes of English law. Each international organisation's constitution will differ, both in its terms and its form; often the constitution does not make express provision for entry into derivative transactions. The question of capacity therefore needs to be considered on a case-by-case basis, and often by reference to any indirect or general powers of the relevant international organisation. Necessarily, the analysis frequently results in reliance being placed on an interpretation of the international organisation's constitution.

Documentation

In many cases, banks and financial institutions will elect to modify their standard documentation to mitigate the risk that their international organisation counterparty may not have capacity to transact. Where parties transact on the basis of an ISDA [International Swaps and Derivatives Association] Master Agreement (and assuming that the International Organisation has capacity to enter into an ISDA Master Agreement itself), the representations in section 3(a) of the Master Agreement will not necessarily provide adequate protection against the consequences of an international organisation entering into a transaction that is outside of its capacity. This is principally because these representations will not be deemed to have been repeated by a counterparty where it purports to enter into a transaction which it has no capacity to enter into. However, if an international organisation has provided additional warranties as to its capacity which can be said to represent an agreed state of affairs in respect of future transactions, it may be estopped from later seeking to resile from that agreement (Credit Suisse International v Stichting Vestia Groep [2014]). This may allow for close-out under the ISDA Master Agreement as if any ultra vires contracts were, in fact, valid. Alternatively, this may provide the basis for a claim in damages for breach of warranty. Careful consideration should therefore be given as to whether it would be beneficial to seek additional warranties prior to transacting with an international organisation, and the precise form they should take.

Close-out netting

On the assumption that the question of capacity can be satisfactorily addressed, a key matter to consider is whether the close-out netting provisions of the Master Agreement would be enforceable against the relevant international organisation counterparty.

The netting opinions available to ISDA members do not usually cover international organisations, so it will usually be necessary to consider the question on a case-by-case basis. It is generally helpful to do this in two sets of circumstances: one where the international organisation counterparty is solvent, and one where it is not solvent. It is necessary to use the term 'solvent' here in a very general manner as there is, of course, no one-size-fits-all test for determining the solvency of international organisations.


"Capacity analysis frequently results in reliance being placed on an interpretation of the international organisation's constitution"


Of the two analyses, the position on insolvency is often less certain. In many cases, it will be unclear as to which courts, if any, would have jurisdiction in respect of such an organisation's insolvency and therefore how any insolvency would be administered. Notwithstanding the technical legal position, an international organisation's insolvency can be expected to have significant political ramifications, and the treatment of creditors' claims would probably depend on the circumstances at the time. In practice, it is often impossible to avoid these risks through the relevant documentation. To mitigate the risk, parties may consider including additional termination rights in their documentation to allow close-out prior to insolvency where the circumstances of the relevant counterparty are deteriorating or its prospects are uncertain. Similarly, counterparties may require additional collateral against their exposures. However the ability to negotiate these terms may be limited by a strong bargaining position of the international organisation.

If the international organisation counterparty is solvent at the point of early termination, the enforceability of the close-out netting provisions is determined primarily by the law of the contract. As a matter of English law, there may be no reason as to why the close-out netting provisions are not, as a matter of principle, enforceable against an international organisation but, again, this needs to be considered on a case by case basis.

Enforcement

Notwithstanding that an international organisation may have legal personality and capacity to enter into OTC derivative transactions, and that the terms of the transactions themselves are binding on it, consideration should be given prior to transacting as to how the terms of those transactions could be enforced should it become necessary to do so.

A key consideration in this regard is the question of immunity. An international organisation's constitutional documents may purport to grant the organisation immunity from suit and/or its assets immunity from execution. Whether it would actually be entitled to rely on immunity from suit in proceedings before an English court or arbitral tribunal would, however, depend on the status of the organisation itself and the terms of the agreement being enforced, among other things. Accordingly, it is important to consider the question of immunity prior to transacting. As part of this process, thought should be given to the proposed forum for resolving disputes and as to whether any waivers of immunity may be necessary or desirable.

The other key consideration is whether effective enforcement action could be taken against the international organisation's assets. This is largely a question of the applicable law in the jurisdiction(s) in which enforcement is sought. Local law advice should be sought in relation to this point prior to transacting. In some instances, it may be desirable to require the parties to collateralise their positions, or for security to be provided in respect of designated and realisable assets.

EU regulatory developments

International organisations have not gone unaffected by EU OTC regulatory developments in recent years. The European Markets Infrastructure Regulation (Emir) takes certain international organisations outside of its scope (save in relation to the reporting obligation), but other international organisations, and counterparties which trade with them, must consider their position on a case-by-case basis. This may involve difficult analysis, particularly in terms of classifying an international organisation within the confines of the terminology used in Emir. From the perspective of international organisations looking to trade with counterparties subject to Emir, advice may be required in relation to terms which the counterparty may request for the purposes of complying with its regulatory obligations. This adds cost to the process of documenting derivative transactions and potentially causes delay while terms are agreed. More fundamentally, it can result in international organisations assuming additional administrative duties in relation to their derivatives trading activity.

By Hogan Lovells partner James Doyle and senior associate Oliver West in London

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