* Barclays and UniCredit fight over deals at the height of
* UniCredit gets no capital relief but may keep guarantees
* Barclays had no time to do due diligence on portfolios
By Owen Sanderson
LONDON, Jan 29 (IFR) - The English Commercial Court found
against UniCredit and in favour of Barclays over EUR20.6bn of
synthetic securitisations structured at the height of the credit
crisis, in a ruling made at the end of December 2012 that has
gone largely unnoticed.
The purpose of the deals, which were struck between September
and December 2008, was regulatory arbitrage.
Barclays agreed, for a premium and fees, to cover
the losses in 3 defined portfolios held by UniCredit, paying the
Italian bank when any of the underlying loans defaulted - up to
EUR1.72bn of losses split among the three deals. Once the
Barclays guarantee had run out, UniCredit would have to cover
This structure allowed UniCredit to tell its
regulator it did not have to hold as much capital against these
portfolios, since Barclays would cover the first losses. But the
economic substance of the deals was that UniCredit continued to
hold all of the risk, because the guaranteed premia and fees to
Barclays would more than cover the losses except in extremely
In other words, UniCredit could get capital relief on the
portfolios and improve its capital ratios, while Barclays would
get an easy profit, taking on very little risk.
While the Court ruled in favour of Barclays, the final
amount has not been determined - the hearing was only on issues
of principle. The judgement states that if the damages Barclays
is awarded are less than the profit it would have received by
keeping the trades in place, it should be able to insist on
UniCredit wants to unwind the deals because BaFin, the
German regulator, decided that it could no longer get any
capital relief in 2010, but Barclays wanted the deal to continue
for the full five years, closing them out in autumn this year.
The contracts allow UniCredit to terminate the deals (with the
consent of Barclays) in various circumstances, but this was only
inserted to get the deal over the regulatory line - Barclays
insisted it was expected to refuse consent until the five-year
term was up.
Barclays wrote protection for UniCredit on first loss
tranches for three trades, covering the first EUR700m of losses
on a EUR9.97bn HVB portfolio, the first EUR600m in a EUR6.63bn
Bank Austria deal, and the first EUR420m in another HVB
portfolio, this time of EUR3.98bn. The bank also sold protection
on the super-senior tranches (between 70% and 100% losses) for
the first six quarters of the deals.
The only way Barclays could have lost out is if the losses
on the deals were very large, and came very close to the
beginning of the deals, meaning it would owe UniCredit money to
make good on the losses, and if interest rates had risen
sharply, meaning the cost of owing UniCredit also rose.
UniCredit was willing to enter into the deal, despite the
expected future loss, because of the regulatory capital it would
save doing so.
The Basel Committee issued guidance on such deals in
December 2011, saying: "Rather than contributing to a prudent
risk management strategy, the primary effect of these high-cost
credit protection transactions may be to structure the premiums
and fees so to receive favourable risk-based capital treatment
in the short term and defer recognition of losses over an
extended period, without meaningful risk mitigation or transfer
Barclays booked profit on the trades immediately, using a
five-year expected life of the deals to calculate its expected
The dispute between the banks arose when BaFin, and the
Austrian regulator (which was following BaFin), decided in 2010
that the deals would no longer give HVB and Bank Austria capital
relief. UniCredit wanted to unwind the trades, since it no
longer got any benefit from them, but Barclays insisted on the
original five-year term of the deals.
The judgement is sympathetic to the design of the deals,
despite their use for regulatory arbitrage, writing that
Barclays "would not have been prepared to take such risk, at any
price, in the current turbulent market conditions (meaning
autumn 2008)", adding "the urgency of the deals and the short
negotiating timescale gave no opportunity to carry
out due diligence on the Reference Portfolios so as to be able
to assess the underlying credit risks of the borrower."
The disputed clause in the original contracts allowed
UniCredit to terminate in the event of a regulatory change, but
Barclays had to agree consent on "commercially reasonable"
Barclays stood to receive fees for the lifetime of the
guarantees, irrespective of the 'premium' it was paid to insure
the portfolios, so it refused to consent to unwinding the
guarantees without payment of the EUR82m it expected to collect
from UniCredit for the five-year expected life of deals.
This dispute itself only arose because of the complexity of
regulatory arbitrage - the intended lifetime of the deal was
five years, but UniCredit may not have received regulatory
capital relief if this was made explicit. However, "the consent
mechanism could be used by Barclays to achieve the same result,
by refusing its consent unless the balance of five years' fees
UniCredit argued, in effect, that Barclays was not being
commercially reasonable in withholding its consent - it was
signed up to pay fees to Barlays for another three years without
gaining any capital relief. Internal documents presented to the
court seem to have shown that Barclays and UniCredit had
different understandings of how firm Barclays could be in
requiring five years of fees.
The Italian lender said that it was treating the refusal of
Barclays to unwind the trade as a waiver of the consent
requirement. After UniCredit unilaterally terminated the deal in
June 2010 Barclays started legal action.
Resolving the dispute at the forthcoming damages hearing
could prove challenging as UniCredit said that it had not been
monitoring the deals since 2010, and that it would be
"impossible" to recreate the portfolios and credit events since
The judgement notes: "The unsatisfactory way in which this
point emerged meant that there was no evidence given by
UniCredit to support this allegation in either form, still less
as to what the difficulty was or when the difficulty or
impossibility arose. That is fatal to the submission."