May 8, 2018 / 11:51 AM / 2 months ago

British hedge fund Caius challenges capital treatment of UniCredit notes

LONDON/MILAN (Reuters) - British hedge fund Caius Capital has asked the European Banking Authority (EBA) to open an investigation into the regulatory treatment of a complex financial instrument as UniCredit’s (CRDI.MI) core capital.

In a May 3 letter seen by Reuters, Caius asked the EBA to examine a 2.98 billion euro ($3.46 billion) convertible bond issued in 2008, which it said had been misclassified as Common Equity Tier (CET) 1, or the best-quality capital held by a bank and a key measure of its financial strength.

Reclassification would reduce UniCredit’s CET 1 ratio by about 50 basis points, a source familiar with the fund’s thinking told Reuters.

According to Caius, UniCredit - Italy’s top bank by assets - should convert the transaction into shares, the source said.

This would increase its CET1 ratio, the source said, but would cause big losses for holders of the instruments, known as convertible and subordinated hybrid equity-linked securities or CASHES. This is because the underlying shares have since lost 94 percent of their value.

The Financial Times, which first reported Caius’s letter, said the fund was likely to profit from such a conversion as it had taken a position betting against the CASHES. A spokesman for Caius declined to comment.

In the letter, Caius blamed the Bank of Italy and the European Central Bank for allowing what it said was the “incorrect regulatory capital treatment derived by UniCredit” from the instruments.

UniCredit said on Tuesday the regulatory treatment of the CASHES had been fully disclosed to the market and confirmed and reviewed by regulators. EBA confirmed it had received the letter from Caius and said it would respond in due course. The Bank of Italy was not immediately able to comment. The ECB did not comment.

Caius said UniCredit incorrectly booked 2.374 billion euros of the CASHES proceeds as CET 1 capital.

“We believe the proceeds derived from the CASHES are ineligible as CET 1 instruments and their existence also makes the ordinary shares of UniCredit ineligible as CET1 instruments,” it said.

UniCredit’s CET1 would fall by about two-thirds, to less than 5 percent, if the underlying ordinary shares did not qualify as core capital, the source familiar with Caius’s thinking said.

Caius said the current treatment of the CASHES “undermines the European level playing field, and risks weakening the perceived quality of CET1 across the EU.”

UniCredit said it had a “very strong” CET1 ratio of 13.6 percent at the end of 2017, adding the CASHES shares’ current contribution to the overall capital position of the bank had no material impact on its regulatory ratios.

In 2011, UniCredit restructured the Cashes to make them eligible for core capital. It said then the move would allow it to keep about 2.4 billion euros, or about 50 basis points, as CET 1 capital as of Sept. 30, 2011 on a pro forma basis.

At 1149 GMT UniCredit shares were down 3.1 percent, with the Italian banking index falling 2.9 percent due to worries about fresh political turmoil. Caius Capital was launched in October, 2016 by former Och-Ziff portfolio manager Antonio Batista and William Douglas, former head of EMEA prime brokerage advisory at Goldman Sachs.

Additional reporting by Agnieszka Flak, editing by Ed Osmond

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