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UniCredit loses fight to unwind EUR20bn capital arbitrage deals
January 29, 2013 / 2:57 PM / 5 years ago

UniCredit loses fight to unwind EUR20bn capital arbitrage deals

* Barclays and UniCredit fight over deals at the height of the crisis

* 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 further losses.

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 unlikely circumstance.

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 keeping them.

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 of risk.”

Barclays booked profit on the trades immediately, using a five-year expected life of the deals to calculate its expected profits.

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” grounds.

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 were paid.”

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 June 2010.

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.”

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