The Italian Derivatives Scam: How towns and regions gambled taxpayer's money

Italian Swap Cases Increase as Merrill Lynch, UBS Sue

Deutsche Bank, UBS and Bank of America’s Merrill Lynch unit in London are suing Lazio, a central Italian region made up of five provinces including Rome, seen here. Photographer: Victor Sokolowicz/Bloomberg

JPMorgan Chase & Co., UBS AG and Bank of America Corp. are among banks bringing more than a half dozen Italian municipalities to London’s courts over swaps that are turning sour for both sides.
The banks are suing towns and regions across Italy, from Florence, a city of about 370,000 people, to Piedmont, the northern region with a population of 4.5 million, as some local governments threaten to stop making payments on contracts and others seek to recover fees they allege were hidden.
Italian municipalities, emboldened by Milan’s criminal trial of Deutsche Bank AG, Depfa Bank Plc, JPMorgan and UBS over allegedly fraudulent selling practices on swaps, are increasingly filing complaints at home to avoid losses on derivatives contracts. The banks are turning to U.K. courts, where they expect to get swifter and fairer judgments.
“Banks have sensed that the wind has turned against them and think they can get a better settlement in a U.K. court,” said Piero Burragato, a former derivatives banker and founder of Concordia Advisory Solutions Srl who isn’t involved in the cases. “The U.K. suits are a sign of concern among the banks.”
The pace of the U.K. lawsuits increased in the past month. Deutsche Bank, UBS and Bank of America’s Merrill Lynch unit in London are suing Lazio, a central Italian region made up of five provinces including Rome. Deutsche Bank and Merrill have also filed suits against Tuscany, and Merrill is suing Piedmont. At least four more suits were filed in London in December against other Italian regions over swap agreements.
Payments Halted
Piedmont hasn’t been notified of the suit and the region has met its obligations on the contract with Merrill, said an official for the government, who declined to be identified. Officials for Florence and Lazio declined to comment, and Tuscan representatives weren’t immediately available. Officials representing all of the banks declined to comment.
Italian municipalities face derivatives losses of at least 1.2 billion euros ($1.6 billion), Bank of Italy data from June 30 show. At least two cities have halted payments on their derivatives deals, stoking tension between banks and clients.
Thousands of public authorities across Europe tried to cut borrowing costs in recent years through derivatives deals whose risks they couldn’t measure. In the U.S., governments and nonprofit organizations have paid more than $4 billion to Wall Street firms to end such agreements since 2008, according to data compiled by Bloomberg.
“Nobody really knows how much of this is out there,” said Michael Dempster, founder of the University of Cambridge’s Centre for Financial Research in the U.K. “It’s indicative of the potential problem in the interaction between banks and local authorities.”
Government Bans
Past losses on derivatives have led some European governments to ban local authorities or state-owned companies from investing in such products. A U.K. court ruled in the 1980s that about 3.2 billion pounds ($5.1 billion) of swap contracts entered into by Hammersmith and Fulham Council were unenforceable. In 1997, the U.K. banned local governments from investing in derivatives. Italy banned local governments from signing new contracts in mid-2008 pending new rules.
Banks are going on the offensive to ensure their cases are heard in London, said Laurence Harris, a litigation lawyer at Edwards Angell Palmer & Dodge LLP in London. Italian courts are more likely to favor the country’s municipalities and the legal system there is slower and subject to limitation periods that could make things harder for the banks.
“Italian proceedings are notorious for taking forever to come to a conclusion; they take years and years,” Harris said. “You can see why they want home-court advantage.”
10-Year Deadline
If municipalities sue first in their jurisdiction, banks have to go there to argue where the case should be heard. That’s used as a tactic in Italy to slow down litigation and try to reach a 10-year deadline after which a lawsuit and any appeals will be thrown out if a ruling hasn’t been made, Harris said.
Cases last year suggest British courts will allow the Italian derivates suits to be heard in the U.K. A British court ruled in May that the Italian bank Dexia Crediop SpA and Irish lender Depfa Bank Plc could sue the city of Pisa in London. UBS also won a ruling in October allowing a dispute with a German municipal utility to be heard in the U.K.
Depfa and Dexia sued Pisa in 2009 for suspending payments on two-interest rate swaps that are governed by U.K. law. Pisa stopped making payments in 2009, claiming that the 95 million euros of bonds and derivatives sold to it by the banks in 2007 didn’t provide an economic advantage to the city. A local administrative court backed its decision.
English Law
“It’s unlikely that the U.K. court would decline to hear any of the cases there since the Pisa case set a precedent, and the swaps contain an exclusive jurisdiction clause in favor of the English courts,” said Dario Loiacono, a Milan-based securities lawyer.
“Italian municipalities want to avoid trying the cases in London because of the cost of litigation, the fear of going to court in a foreign jurisdiction, and because English law is bank-protective,” Loiacono said.
If the banks win in the U.K., they will still have to ask courts in Italy to enforce the judgments, Harris said. Banks could otherwise only seize the assets that municipalities held outside of Italy.
To contact the reporters on this story: Elisa Martinuzzi in Milan at emartinuzzi@bloomberg.net Lindsay Fortado in London at lfortado@bloomberg.net