The Ministry for Economy and Finance enacted on May 27 2004 a Circular on interpretation of the Decree of December 1 2003, n 389 (Decree 389) (see IFLR, International briefings, March 2004) regulating, among other things, derivative transactions for Italian local authorities and regions.
The Circular applies to transactions entered into after February 4 2004, and sets criteria (i) for sinking funds/amortizing swaps; (ii) for derivatives in general; and (iii) for requirements relating to counterparties' ratings.
In connection with sinking funds or amortizing swaps to be put in place by local authorities when issuing notes or entering into loans without amortization of principal pursuant to Article 41 (as defined in our briefings on the March 2004 IFLR edition), the Circular provides that the amounts allocated for the purposes of such a fund or swap shall be invested in certain securities issued by specific categories of issuers only as listed in Decree 389. Furthermore, such funds or swaps shall not undergo any further structuring through derivative transactions with the consequence that the resulting risk profile would fail to comply with the provisions of Article 41 and Decree 389. In any case, the above-mentioned investments in securities shall have maturities no longer than that of the sinking fund.
Article 3 of the Circular better details the types of derivative transactions that local authorities may enter into. More particularly, it is clarified, that: (i) interest rate swaps, forward rate agreements, caps and collars (all as mentioned in such Article 3 of Decree 389) are permitted to the extent that they are plain vanilla transactions; (ii) interest rate swaps cannot in principle include any option or any optionality element in general; and (iii) purchases of collars are allowed only for hedging purposes in respect of possible increases in the interest rates and the level of the rates payable by the local authorities at the reaching of pre-agreed benchmarks must be consistent both with the prevailing market rates and the cost of the underlying debt prior to the entering into of the relevant hedging transaction.
The Circular also gives indications to avoid the concentration of flows close to the final maturity of transactions and offers the flexibility of having a discount/payment of a premium of not more than 1% of the underlying debt as part of the derivative for the restructuring of a financing.
Although the Circular gives an indication that local authorities should not in principle sell options as part of derivative transactions, this would seem permitted in the structuring of transactions aiming at the reduction of the exposure for local authorities against the risk of an increase in interest rates and in general taking into account the possibility of having a discount/a premium of not more than 1%.
Finally, the Circular better details the rating requirements of counterparties of local authorities for derivative transactions. Counterparties must have a certified rating equal to triple-B by Standard & Poor's, Baa by Moody's and triple-B by Fitch Ratings. Any downgrade, even of a single notch, below the indicated levels shall require the termination as soon as possible of all transactions outstanding with the downgraded counterparty. In addition, in the case of transactions with a guarantee of the parent company, the rating of that company shall be relevant for the purposes of the rating requirements.
Only regions that have adopted specific regional legislation expanding the range of transactions permitted under Decree 389 can diverge from these requirements.