Week in Review

December 7, 2012 4:21 pm

Deutsche Bank in spotlight over claims

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Three former Deutsche Bank employees have told regulators that the bank hid billions of dollars of paper losses at the height of the financial crisis.

The three individuals, one trader and two risk managers, approached regulators including the US Securities and Exchange Commission, in 2010 and 2011, said people familiar with the complaints.

They allege that Deutsche misvalued a huge $130bn portfolio of complex derivatives, known as “leveraged super senior” trades, allowing the bank to avoid losses of $4bn-$12bn and helping it avoid a government bailout.

On Wednesday Deutsche said it had investigated the matter thoroughly, starting in 2010, and found the accusations to be “wholly unfounded”. It said it was co-operating with an SEC investigation.

Complaints from the three employees have focused attention on the way banks dealt with extraordinary market conditions in 2007-2009.

The leveraged super senior trades resemble the safest tranche of a typical collateralised debt obligation – in which pools of assets, such as mortgages or credit default swaps – are sliced into layers of varying risk.

In these deals, which started in 2005, Deutsche would buy credit protection from counterparties, many of them Canadian pension funds. It would then sell credit protection on an index and collect the difference between the two.

The “leverage” in the super senior comes from the fact that the counterparties – to make the deal more attractive to them – did not have to post the full amount of collateral. In a typical $1bn they might only post $100m.

Because so many corporate defaults would have to occur before the collateral was wiped out, this was widely seen as safe.

But all three complainants told regulators that Deutsche failed to properly measure the risk that the collateral would not be sufficient and that the counterparty would walk away. It should have offset that against profits, they said.

Deutsche said its treatment was appropriate.

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