December 31, 2014 / 12:41 PM / 5 years ago

Breakingviews: Goldman/Espirito Santo mess raises valid question

LONDON (Reuters Breakingviews) - Goldman Sachs’ Banco Espirito Santo mess raises valid questions. The U.S. bank is threatening legal action after a loan to failed lender Espirito Santo was moved by Portugal’s regulator into BES’ bad bank. Goldman has fallen foul of Portuguese law, and may be a victim of its own complexity, but the fiasco highlights the need for greater clarity over European bank resolution schemes.

The fight between Goldman and the Portuguese central bank dates back to a deal in June, 2014, whereby the U.S. bank loaned BES $835 million to finance a refinery in Venezuela owned by local oil company PDVSA. Goldman intended to sell down $785 million of the loan through a vehicle called Oak Finance. As BES’ situation soured in the following weeks, it was stuck with some of the debt.

Since BES’ resolution protected senior creditors, the Oak Finance loan should in theory have ended up in the good bank carved out of BES, called Novo Banco. Goldman says it got confirmation from the Bank of Portugal that this would be the case. That allowed it to sell more of the debt to investors. Four months later, the regulator has decided the loan should in fact be in the bad bank. That will likely lead to steep losses for Oak Finance.

By shifting the liability, Novo Banco will see its common equity Tier 1 ratio jump to nearly 11 percent, according to CreditSights. The Bank of Portugal’s motives look pure enough: Portuguese law prevents a controlling shareholder from indirectly benefitting from a bailout through claims they are owed. Goldman, thanks to a 2 percent stake in BES, met the “qualified shareholder” test.

The law is clear, but its interpretation by the Portuguese central bank looks rigid. Goldman’s 2 percent stake was temporary, and amassed on behalf of different clients through a separate part of its business. By the end of July, Goldman wasn’t even listed as a main shareholder by the European Commission.

The episode highlights the tricky nature of modern bank bail-ins, which give flexibility to regulators to carve up failing banks, impose losses on creditors, or juggle assets after a resolution. It’s not the first controversy to hit BES: subordinated bondholders are disputing a decision to move a loan to BES’ Angolan unit to the good bank. The new era of bail-ins requires creditors to take losses when banks fail, and so enforce market discipline. It would be good if they could first understand what exact risks they are taking on.

CONTEXT NEWS

- Goldman Sachs said it would pursue “all appropriate remedies” to contest a decision by the Bank of Portugal to leave a $785 million loan to Banco Espirito Santo in the failed lender’s bad bank. The U.S. bank said the Bank of Portugal had previously confirmed in writing that the loan would instead be transferred to Novo Banco, the new entity created after the resolution of BES on Aug. 3.

- “Four months ago, when Novo Banco was created, we sought confirmation from the Bank of Portugal that debts such as the Oak Finance obligations would be transferred to Novo Banco,” a Goldman spokesperson said in an emailed statement. “On August 11, 2014, a senior representative of Bank of Portugal explicitly confirmed to us in writing the transfer of these obligations. In addition, Novo Banco also confirmed in writing that Oak Finance had been transferred as one of its liabilities. The BoP’s unexpected public announcement earlier this week to retroactively return these obligations contravenes market expectations and damages multiple investors, including pension funds, who were offered these investments in reliance on these prior representations. Absent the Central Bank’s reconsidering its position in light of the damage it will be causing to our clients and financial markets, we plan on pursuing all appropriate remedies.”

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

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