Abstract: This document provides an overview of the legal framework governing financial derivatives in Italy, focusing on regulatory classification, contractual elements, and judicial interpretations of key risk disclosure requirements.
1. – General overview.
Derivative financial contracts, according to the original definition of the Bank of Italy, “insist on elements of other trading schemes, such as securities, currencies, interest rates, exchange rates, stock market indices, etc.”. Their “value derives from that of the underlying elements” (Art. 3, update No. 112 of June 23, 1994, to Bank of Italy Circular no. 4 of March 29, 1988).
These contracts are referenced in both European and Italian legislation. Italian law classifies derivatives as “financial instruments” but does not provide a specific definition (see Legislative Decree No. 415 of July 23, 1996—commonly referred to as the “Eurosim” decree—and Article 1 of Legislative Decree No. 58 of February 24, 1998, also known as the “TUF”).
In particular, the TUF includes among the “financial instruments,” various types of derivative contracts, such as “Options contracts, standardized forward financial contracts (“futures”), “swaps,” agreements for future exchange of interest rates and other derivative contracts related to transferable securities, currencies, interest rates or yields, emission allowances, or other derivative financial instruments, financial indices, or financial measures that can be settled with physical delivery or cash payments.”
2. – Legal and regulatory framework for derivatives
As “financial instruments,” derivatives are subject to the general rules of the TUF, along with related regulations issued by the Italian Financial Market Supervisory Authority (CONSOB). These regulations also apply to provisions of the Italian Civil Code. Consequently derivatives:
- are subject to the general rules of the TUF, requiring intermediaries to act with diligence, fairness, and transparency.
- are deemed null and void if executed without a financial intermediation framework contract, leading to potential reimbursements.
- maybe terminated in the event of serious default by the intermediary, leading to potential restitution and/or indemnification measures.
3. – Absence of a normative definition: named but atypical contracts.
Italian law does not provide a specific definition of a derivative contract. Generally, derivatives are considered named but atypical contracts, meaning they do not fall within a specific predefined category. They are a heterogeneous class of contracts linked solely by the fact that their economic outcome depends on varying factors such as interest rates or exchange rates.
This category also includes “swaps,” which are further divided into other heterogeneous contracts, such as, for example, “interest rate swaps” – which we will deal with here – “domestic swaps,” etc.
Swaps involve agreements between two counterparties that agree to exchange cash flows (most commonly, “margins”) based on transactions’ contractual terms.
4. – Purposes of Swaps.
Swaps generally serve one of the following purposes:
- Speculative: Used to profit from expected changes in interest rates or other underlying elements.
- Hedging: Used to mitigate risks, such as interest rate fluctuations.
- Arbitrage: Used to exploit price discrepancies between derivative and underlying assets for risk-free profit.
The intended purpose does not define the type of contract. For example, an Interest Rate Swap (IRS), typically used for hedging, may also be employed for speculative purposes, depending on the investor’s objectives.
(a) Speculative Purpose
A swap is speculative when it aims to profit from favorable interest rate changes between contract execution and settlement. If the investor has declared speculative investment objectives during MiFID profiling, the swap may align with their investment profile.
(b) Hedging Purpose
A swap is commonly used for hedging when a company with a floating-rate loan seeks protection against interest rate fluctuations. For example:
- Company ALFA obtains a €1,000,000 floating-rate loan and seeks to mitigate the risk of rising interest rates.
- ALFA enters into a swap agreement with Bank BETA, agreeing to pay a fixed rate while receiving a floating rate, effectively neutralizing interest rate fluctuations.
- If the floating rate exceeds the fixed rate, BETA compensates ALFA for the difference; if the floating rate is lower, ALFA pays the difference to BETA.
This mechanism allows ALFA to hedge against interest rate volatility.
- – Interest Rate Swaps (IRS)
An Interest Rate Swap involves the exchange of future interest payment obligations. According to the Italian Supreme Court (Cass., S.U., May 12, 2020, No. 8770):
- It is “a contract involving the exchange of future pecuniary obligations, where one party commits to paying a sum calculated based on a fixed interest rate, while the other party commits to a sum based on a floating interest rate.”
- It is an over-the-counter (OTC) derivative, meaning its fundamental aspects are defined by the parties and are not standardized or intended for circulation.
5(a). – Essential Elements of an IRS Contract
According to the Supreme Court, an IRS contract must include:
- The contract execution date.
- The notional amount, which is not exchanged but serves as the basis for interest calculations.
- The contract start date, marking the beginning of interest accrual.
- The contract maturity date.
- Payment dates when interest flows are exchanged.
- The applicable interest rates.
5(b). – IRS Validity and Legal Interpretation
The Supreme Court has ruled that:
- The purpose (causa) of an IRS contract lies in the management of a “rational risk”. Consequently, the agreement must include: (i) the Mark to Market (MTM) and (ii) probabilistic scenarios.
- The absence of these elements would result in the nullity of the contract due to either a defect and/or illegality (on the grounds of lack of meritorious cause under Article 1322 of the Civil Code) or indeterminacy and/or indeterminability of the contract’s object, leading to restitution Ary consequences.
However, an alternative judicial interpretation argues that:
- MTM and probabilistic scenarios are not essential elements of the contract; in particular, they do not pertain to either the object or the cause of the contract.
- Therefore, their absence can never lead to the nullity of the contract but may, at most, be relevant under other aspects, particularly regarding the breach of the intermediary’s disclosure obligations.
The arguments advanced by case law and legal scholarship in support of this position are as follows:
- In swap contracts, the subject matter consists of cash flows (Tribunal of Milan, July 28, 2023, No. 6541, and subsequent decisions).
- MTM expresses, at a given moment, the value of the contract based on projected future cash flows; it therefore corresponds to the theoretical market price that a third party would be willing to pay to assume the contract (Tribunal of Milan, July 28, 2023, No. 6541).
- MTM becomes particularly relevant in cases of early termination of the swap, as it represents the cost demanded by the bank for such termination. However, it does not necessarily constitute a cost that must be paid by the client (Tribunal of Milan, July 28, 2023, No. 6541).
- d) Consequently, an element that is only potentially relevant cannot be classified as essential under the Civil Code. In the event of a request for early termination, any dispute regarding the method of calculating MTM between the parties would give rise to a disagreement over an aspect not expressly regulated by the contract and therefore subject either to the contractual bargaining power of the parties or, in the absence of an agreement, to judicial determination. However, this does not amount to a fundamental defect of the contract, such as the asserted nullity (Tribunal of Milan, July 28, 2023, No. 6541. See also, in the same vein: Tribunal of Milan, March 6, 2023, No. 1717; Tribunal of Spoleto, June 29, 2023, No. 504).
6. – Mark-to-Market (MTM) and Probabilistic Scenarios
6(a). Definition of MTM
According to the Italian Supreme Court (Cassazione), “the so-called mark-to-market (MTM) or replacement cost” is “the cost at which a party may prematurely terminate the contract or at which an unrelated third party, at the valuation date, would be willing to assume the derivative”; in other words, MTM represents “the current market value of the swap (the method in question essentially consists of a daily simulation of the contractual position’s closure and an estimate of the resulting debt/credit of the parties).”
6(b). – Definition of Probabilistic Scenarios
The concept of “probabilistic scenarios” is less clearly defined.
Lower courts have observed that the Supreme Court’s ruling in Joint Chambers Decision No. 8770/2020 “does not specify the content or a particular legal source” for this concept (Tribunal of Turin, February 16, 2022, No. 673). In general, subsequent Supreme Court rulings merely reaffirm that the agreement “must also encompass probabilistic scenarios” or “should address the qualitative and quantitative measure of risk” (see Cass., July 29, 2021, No. 21830; Cass., September 6, 2021, No. 24014; Cass., November 7, 2022, No. 32705; Cass., November 8, 2022, No. 32838; Cass., July 24, 2023, No. 22014). The Milan Court of Appeal has also highlighted the vagueness of the concept of “probabilistic scenarios” (App. Milan, March 22, 2021, No. 921). The court stated that, “in the absence of a more precise specification,” the term “probabilistic scenarios” should be understood as “data emerging from the forward curve” (App. Milan, March 22, 2021, No. 921). The Supreme Court further defines the “forward curve” in Decision No. 21830/2021 as “the future projection of interest rates, upon which risk assumptions are based” (see also App. Florence, October 19, 2023, No. 2124).
The same Milan Court of Appeal clarified that “the omission of information regarding probabilistic scenarios is not significant” if “the derivative contract in dispute is a plain vanilla transaction of objective simplicity, where the expected outcomes are immediately verifiable (for instance, by examining the trend of Euribor rates published on easily accessible websites)” (App. Milan, August 5, 2024, No. 2278).
Shortly after, the Milan Tribunal ruled that “no primary or secondary legislative provision, nor even Supreme Court case law, imposes an obligation on the intermediary to provide a detailed explanation of the probability distribution of the various foreseeable scenarios arising from the execution of the contract”. Specifically, the Milan Tribunal held that the requirement to indicate probabilistic scenarios is met by providing the client with “informational sheets” that include, in addition to “historical data on the performance of the 6-month Euribor,” also “simulated scenarios illustrating the effects of contract execution in the event of interest rate increases or decreases, in order to provide awareness of the different possible risk scenarios arising from contract execution” (Trib. Milan, October 25, 2024, No. 9321).
More recently, the Milan Court of Appeal ruled in 20 February 2025 on a dispute concerning an OTC IRS derivative, aligning itself with the guidance provided by the Supreme Court regarding Mark-to-Market valuation and probabilistic scenarios. These elements were considered by the Court to be essential components of the IRS contract, leading it to reject the appellant’s request, as the bank’s documentation kit was deemed complete. This decision is noteworthy because, after verifying the accuracy of the Mark-to-Market value of the OTC derivative in question, the Court also assessed the bank’s substantive compliance with all pre-contractual disclosure obligations incumbent upon it, ultimately confirming the correctness of its conduct. Specifically, the Court stated that the Mark-to-Market value must be considered calculable even if its determination requires the application of sophisticated algorithms, which can be obtained from specialized information providers.
From an operational standpoint, banks must therefore exercise due diligence with respect to these elements, avoiding reliance on standardized models or simplified calculations, which do not constitute proper fulfillment of the duty to inform.
7. – Consequences of Breaching Disclosure Obligations
The potential consequences of a breach of disclosure obligations regarding MTM and probabilistic scenarios, in addition to nullity, include:
- Termination of the contract (provided that the conditions set forth in Article 1455 of the Civil Code are met, i.e., the materiality of the breach), with the consequent restitutionary effects.
- Compensation for damages. In this regard, both case law and the Financial Dispute Arbitrator (ACF) established before Consob have repeatedly applied the principle of “more likely than not” (più probabile che non). Specifically, the ACF has held that, from a counterfactual perspective, “it should also be noted, according to the principle of ‘more likely than not,’ that even in the presence of clearer disclosure, the claimant would have nonetheless accepted and signed the IRS, as it met the need to enter into a variable-rate loan with the coverage of a derivative contract” (ACF, Decision No. 6054 of November 9, 2022).
8. – Regulatory requirements
The analysis carried out focused on case law to provide a concise yet comprehensive overview of the legal framework. Having established this foundation, attention can now shift to the relevant regulatory requirements that shape the Italian legal landscape. In essence, there are no specific Italian regulations uniquely governing derivatives; instead, the applicable framework is derived from EU-level directives and regulations. These include the Markets in Financial Instruments Directive II (MiFID II), which governs investment services, the European Market Infrastructure Regulation (EMIR), which addresses derivatives trading and clearing obligations, and the Financial Collateral Directive, which harmonizes collateral arrangements. Collectively, these regulatory instruments establish a uniform legal structure across the European Union, ensuring consistency and legal certainty in the derivatives market.
From a practical perspective, one should note that several complaints and some litigation between banks (or investment firms) and clients dealing in OTC derivatives have focused on how a bank (or an investment firm) assesses whether a private individual (e.g., an Italian limited liability company) investor may be treated, upon request, as a professional client under MiFID II.
As a reminder, in accordance with the third paragraph of Section II.1, I of Annex II of MiFID II, private individual investors may be treated as professional clients only if an adequate assessment of their expertise, experience, and knowledge provides reasonable assurance, in light of the nature of the transactions or services envisaged, that the client is capable of making investment decisions and understanding the risks involved.
The Italian competent authority is aligned with ESMA’s 2018 position and allows some of the protections afforded to retail clients to be waived but points out that the MiFID II waiver is expected to be relied upon in a reasonable manner that is consistent with the overarching duty to act in the best interest of clients.
For instance, the fulfillment by a private individual investor of two of the criteria provided in the fifth paragraph of Sub-Section II.1 is considered an indication that such a client may be treated as a professional client. However, Consob has pointed out that such a test might not be sufficient to justify accepting a request for a waiver under Sub-Section II.2. Depending on the category of products the client intends to trade (e.g., OTC derivatives), a more thorough analysis of the client’s expertise, experience, and knowledge may be required.
In short, banks and investment firms should not automatically accept as professional clients those who meet two or more of these criteria, since, in accordance with the second paragraph of Section II.2, they are expected to take all reasonable steps to ensure that a retail client requesting to be treated as a professional client meets the requirements of Section II.1.
By way of example, banks should avoid relying solely on self-certification by the client and should consider obtaining further evidence to support assertions that the client meets the identification criteria at that point in time, particularly when they determine that the documents or statements received from the client are not sufficiently conclusive. For instance, knowledge gathered in relation to simple products may not be relied upon when a private individual investor requests to be treated as a professional client for more complex products (e.g., knowledge related to vanilla government bonds should not be relevant with respect to envisaged transactions in complex derivatives).
In conclusion, the assessment conducted by the investment firm of the client’s expertise, experience, and knowledge must provide the firm with reasonable assurance that the client is capable of making investment decisions and understanding the risks involved with respect to each type of transaction and service envisaged.