* CVA securitisation falls foul of latest regulatory
* Bonus structure had provided sizeable regulatory capital
* Credit Suisse expected to change flawed transaction
By Christopher Whittall
LONDON, Feb 27 (IFR) - Credit Suisse may be forced to scrap
or, at the very least, radically restructure a multi-billion
dollar employee bonus scheme that represents an important part
of its efforts to boost capital by slashing risk-weighted assets
in the investment bank.
The Swiss bank's Partner Asset Facility (PAF) 2 scheme was
introduced in 2012 as part of its annual compensation pool
awarded to over 6,000 senior staff. It consists of a series of
structured notes that reference an underlying pool of
counterparty credit risk exposures stemming from the bank's
Credit Suisse never revealed the regulatory capital relief
afforded by PAF2 - only referring to "material risk reductions"
- but it is likely to be sizeable: at inception, the structure
covered 18% of the credit exposure in the bank's derivatives
These billions of dollars worth of capital savings look set
to disappear, though, as the bank's year-end financial
statements reveal the PAF2 transaction involves a hedging
structure that falls well short of the latest regulatory
The PAF2 structure - which covers approximately USD12bn
notional of expected exposures from the bank's derivatives
counterparties - is sliced into three tranches: a technique
since prohibited by the Basel Committee for counterparty risk
hedges. Credit Suisse retained a USD500m first loss tranche,
while senior employees receive coupons of 5% to 6.5% per year
from a USD800m mezzanine tranche.
But perhaps more significant is the flawed structure used to
hedge the senior tranche of the PAF2 deal, which at USD11bn is
by far the largest slice of risk in the portfolio.
Credit Suisse purchased protection from a third party
investor - named as Guggenheim Partners by one market source -
through a credit default swap accounted for at fair value,
according to the bank's fourth quarter results.
The problematic part of the hedge is as follows: Credit
Suisse has extended a multi-billion dollar credit facility to
the un-named investor, which requires the bank to "fund payments
or costs related to amounts due by the entity under the CDS".
In other words, the investor can borrow money from Credit
Suisse to make CDS payments to the bank if the senior tranche
loses money - hardly a genuine risk transfer.
"There's no question that Credit Suisse will have to
restructure PAF2," said one bank capital expert. "The latest
Basel III guidelines all but cite Credit Suisse as an example of
what not to do."
Credit Suisse declined to comment. However, sources within
the bank said: "While PAF2 is working as a true economic hedge
that transfers risk to employees, the continued evolution of the
Basel III rules is likely to require some modifications to the
hedge. These changes are already well advanced."
PAF2 was an important plank in Credit Suisse's plan to
transition to Basel III by 2013 - five years ahead of most of
its peers - by aggressively cutting risk-weighted assets from
CHF370bn in September 2011 to CHF293bn currently.
Basel III lumps a hefty capital charge on the credit value
adjustments (CVA) associated with derivatives exposures,
incentivising banks to try and repackage this risk and sell it
on to investors.
Credit Suisse's PAF2 scheme represented the first
publicly-detailed securitisation of CVA since the financial
crisis. UBS and Deutsche Bank have also executed privately
placed deals, while it emerged last week that Societe Generale
is lining up a CVA securitisation to sell to third-party
But Credit Suisse has shown the risk of executing a deal
prior to the regulations being finalised. The Basel Committee
has since stated that tranched securitisations would not
constitute eligible hedges for CVA exposures, seemingly because
this may open the door to leveraged structures.
A set of "Frequently Asked Questions" from the Basel
Committee last November goes a step further, specifically
outlawing structures similar to PAF2.
In one section, the Committee states that if a bank remains
exposed to a tranche of underlying default risk by providing
"any form of credit enhancement to the protection provider, then
the CDS is not an eligible CVA hedge." The Committee further
clarifies this to be the case even if the credit facility is
subject to accrual accounting - as in the case of Credit Suisse.
The Credit Suisse guarantee facility is four-years in
maturity and can be extended to nine years, although the bank
has the right to terminate the transaction for certain reasons
"including certain regulatory developments". Analysis of Credit
Suisse accounts indicates the facility could be as large as
Guggenheim Partners is well known for its connections with
Credit Suisse. Two members of the firm's executive committee -
its president, Todd Boehly, and chief investment officer, Scott
Minerd - worked for Credit Suisse First Boston prior to joining.
Guggenheim Partners did not return a request for comment.
FINMA - the Swiss bank's regulator - declined to comment on
whether Credit Suisse would be forced to restructure the PAF2
bonus scheme, saying it did not comment on individual cases.
(Reporting By Christopher Whittall, editing by Helen
Bartholomew and John Mastrini)