Last checked at 
* Barclays and UniCredit fight over deals at the height ofthe 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 foundagainst UniCredit and in favour of Barclays over EUR20.6bn ofsynthetic securitisations structured at the height of the creditcrisis, in a ruling made at the end of December 2012 that hasgone largely unnoticed. The purpose of the deals, which were struck between Septemberand December 2008, was regulatory arbitrage.
Barclays agreed, for a premium and fees, to coverthe losses in 3 defined portfolios held by UniCredit, paying theItalian bank when any of the underlying loans defaulted - up toEUR1.72bn of losses split among the three deals. Once theBarclays guarantee had run out, UniCredit would have to coverfurther losses.
This structure allowed UniCredit to tell itsregulator it did not have to hold as much capital against theseportfolios, since Barclays would cover the first losses. But theeconomic substance of the deals was that UniCredit continued tohold all of the risk, because the guaranteed premia and fees toBarclays would more than cover the losses except in extremelyunlikely circumstance.
In other words, UniCredit could get capital relief on theportfolios and improve its capital ratios, while Barclays wouldget an easy profit, taking on very little risk.
While the Court ruled in favour of Barclays, the finalamount has not been determined - the hearing was only on issuesof principle. The judgement states that if the damages Barclaysis awarded are less than the profit it would have received bykeeping the trades in place, it should be able to insist onkeeping them.
UniCredit wants to unwind the deals because BaFin, theGerman regulator, decided that it could no longer get anycapital relief in 2010, but Barclays wanted the deal to continuefor the full five years, closing them out in autumn this year.The contracts allow UniCredit to terminate the deals (with theconsent of Barclays) in various circumstances, but this was onlyinserted to get the deal over the regulatory line - Barclaysinsisted it was expected to refuse consent until the five-yearterm was up.
PROTECTION STRUCTURES
Barclays wrote protection for UniCredit on first losstranches for three trades, covering the first EUR700m of losseson a EUR9.97bn HVB portfolio, the first EUR600m in a EUR6.63bnBank Austria deal, and the first EUR420m in another HVBportfolio, this time of EUR3.98bn. The bank also sold protectionon the super-senior tranches (between 70% and 100% losses) forthe first six quarters of the deals.
The only way Barclays could have lost out is if the losseson the deals were very large, and came very close to thebeginning of the deals, meaning it would owe UniCredit money tomake good on the losses, and if interest rates had risensharply, meaning the cost of owing UniCredit also rose.UniCredit was willing to enter into the deal, despite theexpected future loss, because of the regulatory capital it wouldsave doing so.
The Basel Committee issued guidance on such deals inDecember 2011, saying: "Rather than contributing to a prudentrisk management strategy, the primary effect of these high-costcredit protection transactions may be to structure the premiumsand fees so to receive favourable risk-based capital treatmentin the short term and defer recognition of losses over anextended period, without meaningful risk mitigation or transferof risk."
Barclays booked profit on the trades immediately, using afive-year expected life of the deals to calculate its expectedprofits.
The dispute between the banks arose when BaFin, and theAustrian regulator (which was following BaFin), decided in 2010that the deals would no longer give HVB and Bank Austria capitalrelief. UniCredit wanted to unwind the trades, since it nolonger got any benefit from them, but Barclays insisted on theoriginal five-year term of the deals.
The judgement is sympathetic to the design of the deals,despite their use for regulatory arbitrage, writing thatBarclays "would not have been prepared to take such risk, at anyprice, in the current turbulent market conditions (meaningautumn 2008)", adding "the urgency of the deals and the shortnegotiating timescale gave no opportunity to carryout due diligence on the Reference Portfolios so as to be ableto assess the underlying credit risks of the borrower."
DISPUTED GROUND
The disputed clause in the original contracts allowedUniCredit to terminate in the event of a regulatory change, butBarclays had to agree consent on "commercially reasonable"grounds.
Barclays stood to receive fees for the lifetime of theguarantees, irrespective of the 'premium' it was paid to insurethe portfolios, so it refused to consent to unwinding theguarantees without payment of the EUR82m it expected to collectfrom UniCredit for the five-year expected life of deals.
This dispute itself only arose because of the complexity ofregulatory arbitrage - the intended lifetime of the deal wasfive years, but UniCredit may not have received regulatorycapital relief if this was made explicit. However, "the consentmechanism could be used by Barclays to achieve the same result,by refusing its consent unless the balance of five years' feeswere paid."
UniCredit argued, in effect, that Barclays was not beingcommercially reasonable in withholding its consent - it wassigned up to pay fees to Barlays for another three years withoutgaining any capital relief. Internal documents presented to thecourt seem to have shown that Barclays and UniCredit haddifferent understandings of how firm Barclays could be inrequiring five years of fees.
The Italian lender said that it was treating the refusal ofBarclays to unwind the trade as a waiver of the consentrequirement. After UniCredit unilaterally terminated the deal inJune 2010 Barclays started legal action.
Resolving the dispute at the forthcoming damages hearingcould prove challenging as UniCredit said that it had not beenmonitoring the deals since 2010, and that it would be"impossible" to recreate the portfolios and credit events sinceJune 2010.
The judgement notes: "The unsatisfactory way in which thispoint emerged meant that there was no evidence given by UniCredit to support this allegation in either form, still lessas to what the difficulty was or when the difficulty orimpossibility arose. That is fatal to the submission."
