Italian Senate Finance Committee Acts to Restrict Municipal Derivatives


As we reported in our May 2009 publication, on April 27, 2009, Italian financial police, acting on the order of a judge, seized millions of Euros of assets of four large banks in connection with a probe relating to derivatives transactions entered into by the city of Milan.  On March 17th, these four banks, eleven bankers and two former city officials were charged with fraud in connection with these transactions.  Prosecutors claim that the banks fraudulently profited €100 million in fees from the city which were not properly disclosed under these transactions.  Moreover, it has been reported that at least one of these transactions included an interest rate “collar”, which required the city to make payments to the bank if interest rates went below the specified floor, which they did.  It is not clear whether, and to what extent, the banks disclosed the risks inherent in such transactions and whether city officials adequately understood these risks.

Against the backdrop of this ongoing case involving Italy’s financial center, on March 11th, the Italian Senate Finance Committee (the “Committee”) unanimously approved a proposal (the “Proposal”) that would restrict the use of derivatives by municipalities.  The Proposal is the culmination of a year-long review by the Committee prompted by a rash of losses incurred (and negative values accrued) by many Italian municipalities during the credit crisis.  In all, Italian municipal entities reportedly face potential losses of €2.5 billion on derivatives.

Among other things, the Proposal would limit the use of derivatives to towns having at least 100,000 residents (other than capitals of provinces), ban upfront payments and compel municipalities to obtain an opinion from the Economy Ministry (until now, they only had to show the contract to the ministry) before execution of any transaction.  According to the chairman of the Committee, the Proposal would require municipalities to prove that execution of a derivative transaction would put them in a better position than repaying their current debt.

As we reported last May, concern about municipal derivatives is not isolated to Italy.  Local governmental entities in Germany and the United States (including, most notably, Jefferson County in Alabama) continue to struggle with the aftermath of trades that went significantly out-of-the-money to them.