Breakingviews-Four questions Monte dei Paschi must answer

Wed Jan 23, 2013 9:25pm IST

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(The authors are Reuters Breakingviews columnists. The opinions expressed are their own)

By Neil Unmack and Dominic Elliott

LONDON, Jan 23 (Reuters Breakingviews) - Banca Monte dei Paschi di Siena (BMPS.MI) is on the spot. The Italian bank – the world's oldest - is probing how bizarre derivatives trades racked up hundreds of millions of euros of losses. It is promising to come clean about how it got into the mess. Here are the four questions that investors and taxpayers need answered.

Why was a commercial bank gorging on structured derivatives?

The derivatives trades date back to at least 2002, when MPS and Deutsche Bank (DBKGn.DE) set up an off balance sheet vehicle called Santorini whose assets mainly comprised shares, or derivatives linked to shares, in another lender, San Paolo IMI. The precise structure and purpose of this vehicle isn't clear. One possible explanation is that MPS wanted to cash in its Intesa shares but retain some upside exposure. MPS needs to say what Santorini's real function was. Another trade relates to a so-called "CDO squared" - a highly leveraged structured product - that MPS originally bought from Dresdner.

Why did MPS restructure the trades?

By 2008, the Santorini vehicle was making losses, Bloomberg reported. In response, MPS restructured it, again with help from Deutsche. The CDO squared was restructured in 2009 in a transaction with Nomura (8604.T). Though the deals are complex, what is clear is that they both involved MPS taking on different kinds of risk, this time linked to Italian government credit and interest rates. The restructurings may have allowed the bank to avoid recognising losses in the immediate aftermath of the financial meltdown, but left it exposed when the euro crisis struck. Last year, the bank took an additional 500 million euros of state bailout money as a direct result of structured trades linked to government debt. Il Fatto Quotidiano, an Italian website, reported on Jan. 22 that losses on the Nomura deal alone could be 220 million euros or higher. MPS says it is reviewing the accounting treatment of the transactions. It also needs to say why it made such a potentially reckless move.

Why weren’t the deals disclosed more clearly?

Given the potential losses facing MPS and Italian taxpayers that funded the bank's bailout, it’s equally surprising that the 2008/2009 trades weren’t explained in the bank's annual results. True, MPS was probably keen to avoid making itself appear vulnerable by giving away too much information to other market participants. But it ought to have made investors aware in general terms about what was going on. Even the bank’s auditor, KPMG, says it did not know about the Nomura trade.

So who knew about the trades, and who approved them?

Deutsche Bank says the restructuring of Santorini was given the necessary approvals by MPS, and that the Italian bank also received independent advice. Nomura says the MPS board and Giuseppe Mussari, who stepped down as executive chairman last summer, approved the 2009 transaction. However, MPS says the board did not rubber-stamp the deal. Mussari resigned from his position as head of the Italian Banking Association on Jan. 22, saying he had always respected the rules of the ABI. He made no comment regarding the MPS derivatives, and could not be reached directly. The precise chain of approval needs to be made clear if investors – and taxpayers - are to hold those responsible for the losses to account.

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CONTEXT NEWS

- The former chairman of Banca Monte dei Paschi di Siena on Jan. 22 stepped down as head of Italy's ABI banking lobby following a report by Il Fatto Quotidiano, an Italian website, that the bank would book a 220 million euro loss on a derivatives contract in its 2012 results.

- Giuseppe Mussari, who stepped down from MPS in 2012, announced his resignation from the ABI in a statement that did not mention the Sienese bank or the derivatives contract. He said he had always respected the rules of the ABI, but did not want to harm the ABI in any way, even indirectly.

- Nomura, which designed the 2009 derivatives deal for Monte dei Paschi, said on Jan. 22 the trade had been reviewed by the Italian bank's external auditors, KPMG, and approved by the board and Mussari.

- MPS said its board had not reviewed the trade for approval. KPMG said on Jan. 22 that it had "never been informed of any confidential agreement between MPS and Nomura" and "never approved, and certainly not on a preliminary basis, the financial transaction structures covered by such confidential agreements".

- In 2012, MPS received a 3.9 billion euro bailout from the Italian state, largely as a result of its holdings of government debt. The bailout was 500 million euros larger than previously expected because of what the bank called "structured transactions" linked to sovereign debt.

- The bank said on Jan. 18 it "is analysing the legal, financial, accounting and bookkeeping profile of the transactions and intends to accurately assess any potential, current and prospective impact from the deals."

- Bloomberg reported on Jan. 17 that MPS used a derivative transaction with Deutsche Bank, called Project Santorini, to obscure a 367 million euro loss during the financial crisis in 2008.

- Deutsche Bank said on Jan. 23 in an emailed statement that the deal “was subject to our rigorous internal approval processes and also received the requisite approvals of the client who was independently advised.”

- MPS shares fell a further 5 percent to 0.26 euros on the morning of Jan. 23. They have fallen 12 percent in a week.

- Mussari statement: link.reuters.com/rut45t

- MPS statement: link.reuters.com/sut45t

- Reuters: Monte Paschi shares plunge on derivative loss fears [ID:nL6N0AS5P0]

(Additional reporting by George Hay)

- For previous columns by the author, Reuters customers can click on [UNMACK/]

(Editing by Peter Thal Larsen and David Evans)

((neil.unmack@thomsonreuters.com))

((Reuters messaging: neil.unmack.thomsonreuters.com@reuters.net)) Keywords: BREAKINGVIEWS MPS/

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