Legislation on derivatives for Italian local authorities is scant. The only provisions are contained in Ministerial Decree No 420 of July 5 1996 (MD No 420) and in Article 41 of Law No 448 of December 28 2001 (2002 Financial Law).
MD No 420 applies only to provinces and municipalities and provides for compulsory hedging against currency risks. The 2002 Financial Law expressly provides that local authorities may issue notes on a bullet basis if associated with derivative transactions recreating an amortization effect.
Italian local authorities have entered into numerous hedging transactions on the basis of general principles of law rather than specific domestic legislation, and on the basis of the requirement introduced in 1998 to reduce their deficits to meet the demands of the Internal Stability Act.
In line with this target, Article 41 of the 2002 Financial Law conferred on the Ministry of Economy and Finance the power to supervise the access by local authorities to the capital markets. The Ministry was meant to issue a decree containing provisions on the coordination of financial activities with the Ministry of Economy and Finance and guidelines on hedging.
The Ministry is still to enact such a decree, although it has prepared various drafts.
The general rule for swap transactions with local authorities is that they should be used exclusively for hedging against exchange and currency risks. Swap transactions for the purpose of creating liquidity, such as maturity swaps, are forbidden. However, the latest draft decree, yet to be approved, seems to permit the payment of an up-front to a local authority for sales of options not exceeding 1% of the relevant notional amounts.
So, the criteria to follow when entering into a derivative transaction with a local authority are the following: the transaction should be justified taking into account the economic balance of the local authority; it should not cause a debt increase; it should be approved by the competent bodies of the local authority; it should be entered into on the basis of the financial terms and conditions prevailing at the time of its execution; the liquidity generated by an up-front deriving from the payment of the option (subject to the restrictions contained in the draft decree) should not be used to cover public deficits.