By judgment no. 12 of 24 January 2024, the First Central Division of the Court of Accounts, in fully confirming the first instance judgment (Court of Accounts no. 2/2022), declared the lack of jurisdiction over the banks involved in the case in question and the compliance of the derivatives transaction carried out by the Region of Basilicata with the criteria of rationality and cost-effectiveness.
The dispute stems from the derivative hedging transaction carried out by the Region of Basilicata in 2006, the underlying of which was a variable rate loan entered into to finance the reconstruction works following the earthquake of 9 September 1998. Through derivative contracts, the banks have synthetically transformed a floating-rate debt (of uncertain amount and with ex ante growth prospects) into a fixed-rate debt (whose amount and interest to be paid were certain). This allowed the Region to adequately plan its budget, also ensuring additional funds, although for a relatively small amount, but necessary for the completion of the post-earthquake reconstruction works already planned.
The key points of the judgment are essentially two: (i) the first concerns jurisdiction over banks in proceedings that normally involve only the officials of local authorities held responsible for treasury liability for the damages caused to the local authority; (ii) the second concerns the merits of the proceedings, and therefore the transaction carried out by the Region and contested by the prosecution due to the alleged irrational and uneconomic aspects.
As regards jurisdiction, the Court upheld the judgment delivered at first instance. The Prosecutor did not provide evidence capable of proving the existence of the service relationship on the part of the banks. In other words, the Prosecutor has not proven that the relationship between the banks and the Region was different from a relationship of a private nature and that the banks would have interfered or replaced the organizational structure of the Region, exercising public functions or that the banks have influenced the Region’s choices in the restructuring and management of public debt in a decisive manner to be liable for damages allegedly caused to the Region by the derivative transaction together with the officials and political representatives of the Region.
The judgment of the first instance was also fully confirmed on the merits: the transaction met the criteria of rationality and cost-effectiveness and unequivocally fulfilled its hedging function.
The transaction included a capital swap component which allowed the Region to obtain additional funds (albeit of a relatively small amount) necessary for post-earthquake reconstruction works. This resulted in the contractual mismatch between the notional amount of the derivative contracts and the amount of the underlying loan.
This difference in the notional amounts was utilized by the prosecution as a presumptive index of the lack of the hedging function of the transaction, but it was correctly framed by the Court. According to the Court, this difference was aimed at achieving the additional funds and therefore, it was aimed at collecting the funds necessary to carry out the reconstruction works.
The Court thus emphasized the “composite purpose of the transaction, consisting both in protection against interest rate risk and in ensuring that the Region had the necessary funds to finance the earthquake reconstruction works” as well as the perfect correspondence between the variable leg of the derivative (paid by the banks to the Region) and the amounts that the Region had to pay pursuant to the underlying loan “allowing derivative contracts to pursue a full and indisputable hedging purpose“.
In this way, the Court reaffirmed the rationality of the transaction, which is proven by the ability of the transaction to cover the investor (public entity) against the risk of increasing interest rates above a certain threshold that could have been incompatible with the financial statements of the public entity. “By establishing a fixed interest rate, as opposed to the original variable interest rate, the investor instead neutralizes this risk and can plan expenditure commitments with the certainty that the interest expense can never exceed the predetermined threshold.”
Moreover, on the basis of the forward curve, such fixed interest rate was lower than the estimated floating interest rate for at least half of the duration of the derivative contracts.
The Court did not even doubt the cost-effectiveness of the transaction since the fixed interest rate agreed with the banks in the derivative contracts was more advantageous than the one the Region could have obtained on a similar and hypothetical fixed-rate loan and was aligned with the market interest rates applicable at the time.
In conclusion, leaving aside the issue of jurisdiction on which the Court retraces and applies to the case the principles already enunciated by case law, it is on the issue of the hedging of derivatives that the judgment unfolds with particular value. In assessing the correlation between the underlying debt and the hedging of derivative contracts, the Court emphasizes the composite purpose of the transaction, evaluated in concrete terms, thereby disagreeing with the abstract and formalistic approach used by the prosecution and, in some cases, also by civil courts in Italy (see, among others, Court of Genoa, no. 698/2021).
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