Morgan Stanley in €2.57bn Italy payout Morgan Stanley asked Italy to cancel billions of dollars worth of outstanding derivatives contracts, generating a €2.57bn payout from the Italian Treasury to the investment bank. The bank used an unusual legal clause, linked to "additional termination events," to press the Italian Treasury into cancelling the derivatives earlier this year. These included interest rate swaps struck with the bank more than 20 years ago, according to government transcripts released last week. IN US & Canadian Companies "This clause, which dates back to the date of signing the contract, in 1994, was unique and is not present in any other contract between the ministry and its counterparties," said Marco Rossi Doria, the education undersecretary in charge of responding to parliamentary questions on derivatives. The Italian government paid €2.57bn ($3.4bn) to Morgan Stanley to close out the trades, said Mr Doria. This agreement was likely to have occurred because the bank was "in the money" on the contracts, meaning the market value of the derivatives had moved in Morgan Stanley's favour, allowing the payout. Concerns over Morgan Stanley's exposure to troubled eurozone peripherals hit the New York-based bank's share price late last year. But cancelling the contracts reduced Morgan Stanley's Italian exposure by more than two-thirds to $1.52bn - a decrease so material it had to be disclosed in the bank's full-year results released in January. The bank said that it had "executed certain derivative restructuring amendments," generating $600m of additional earnings in the fourth quarter, but did not explain how it had reduced its exposure to Italy by cancelling the contracts. This sparked intense speculation among derivatives specialists. Other US banks with significant exposure to troubled eurozone peripherals were thought to be hoping to emulate Morgan Stanley's move. Figures released as part of the European banking stress tests suggested that European banks alone were "in the money" on their Italian derivatives deals by €5.12bn at the end of 2010. Equivalent numbers for US banks are unknown. "Lots of US banks in particular, are sitting on interest rate swaps done years ago with Italy that are deep in the money," said one derivatives specialist. For many banks this exposure runs into billions. But market participants say the termination clause which allowed Morgan Stanley to unwind its agreements with Italy is fairly uncommon. There's no definition of "additional termination events," in the standard rules which govern derivatives, meaning they have to be privately negotiated between parties in a contract. People familiar with the transactions say Morgan Stanley's role as Italy's prime broker may have given it the leverage needed to include the clause in the derivatives agreements. The "events" are typically linked to a credit ratings downgrade or failure to meet certain financial tests. Morgan Stanley moved to close its derivatives contracts during a period when spreads on Italian sovereign debt were close to record highs. Since then spreads on Italian 10-year bonds have fallen to less than 300 points over German Bunds. US and European banks have sought to re-enter the Italian debt market, partly because of liberalising measures undertaken by the technocratic government of Mario Monti, according to several bank risk managers contacted by the Financial Times. Market participants say that closing the derivatives may have also helped reduce the spreads of credit default swaps on Italy, which have fallen from 484 basis points at the start of the year to 357 bps. This is because banks that are "in the money" on derivatives agreements such as interest rate swaps, typically buy CDS protection to hedge this exposure. Morgan Stanley declined to comment. With additional reporting by Lisa Pollack in London.