Secret Irish Derivatives Stay Hidden After Bank Crisis

Photographer: David Levenson/Bloomberg

Deirdre Somers, chief executive of the Irish Stock Exchange. Close

Deirdre Somers, chief executive of the Irish Stock Exchange.

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Photographer: David Levenson/Bloomberg

Deirdre Somers, chief executive of the Irish Stock Exchange.

Six years ago, an obscure financial instrument hastened the demise of Anglo Irish Bank Corp., the lender which helped drive Ireland into an international bailout. Today, those instruments remain in the shadows.

Two of the bank’s former directors this week face sentencing after being convicted of a loans-for-shares scheme aimed at stopping a secret stake in the lender flooding on to the market in 2008. The family of Ireland’s then richest man had clandestinely built the 28 percent stake, using derivatives known as contracts for difference, or CFDs.

During the trial, Judge Martin Nolan described CFDs as “a volatile form of gambling.” Yet the government still hasn’t implemented European rules that require more disclosure, almost a year after they were handed down and five years after the U.K. took its own initiative to stop investors secretly building significant stakes using the instruments.

“It’s outrageous,” Deirdre Somers, chief executive officer of the Irish Stock Exchange, said in an interview last month. “The government is presiding over a situation where they’re incentivizing the market to be totally opaque and fundamentally, as proven before, destructive. Nothing has changed.”

In the wake of the Quinn gamble and the nation’s real estate crash, the government spent about 30 billion euros ($40 billion) saving Anglo Irish before shutting it down.

In October 2010, the finance ministry said it would bring forward rules on the reporting of CFD positions within weeks. Within months, Prime Minister Brian Cowen’s government had fallen after negotiating an international bailout and the proposals were shelved as the European Union weighed new bloc-wides rules.

Financial Disclosure

During its EU presidency last year, Ireland “steered the negotiations” on rules covering financial disclosure, the ministry said in a statement.

EU members have two years from the time the directive was enforced in November to adopt it into national law. In Ireland, legislation “is likely to be introduced in early 2015,” the ministry said in an e-mail response to questions on July 25.

CFDs allow investors to bet on a share price by only putting up an initial deposit of as little as 10 percent of the price of the stock. Investors are asked by a broker to deposit more cash or securities to cover any losses, known as a margin call. They can also have agreements with their CFD providers to buy the underlying shares at a later date.

Investors who build a stake of more than a 3 percent equity stake in an Irish-listed company usually have to disclose their positions to the stock market. That’s not the case with stakes built through CFDs.

“There are massive transparency issues,” said Shaen Corbet, a finance lecturer in Dublin City University and former CFD trader. “We’ve seen one serious situation with CFDs and have not closed off the channels for re-occurrence.”

Sean Quinn

The instruments rose to prominence in Ireland after the family of tycoon Sean Quinn wagered on Anglo Irish shares using CFDs, starting in 2006.

As the value of the shares underpinning the bet plunged, the Quinns were forced to cut their exposure. Anglo Irish lent 450 million euros ($604 million) to 10 of its wealthiest clients to help soak up shares underlying the derivatives.

A jury decided the loans weren’t in the bank’s ordinary course of business, and convicted former Anglo Irish Bank Corp. executives Pat Whelan and Willie McAteer of allowing the loans.

Judge Nolan will lay out their punishment on July 31, after indicating he favors community service and criticizing regulators for failing to block the deal.

In the U.K., regulators in 2009 introduced rules that required CFD holders to disclose their position once it passes the equivalent of a 3 percent stake.

“Maybe it’s just an example of Irish short-termism,” said Corbet. “The risk of a repeat remains.”

Financial Rebound

CFDs are regaining popularity among the Irish as the country rebounds from the financial crisis, according to Joe Rundle, head of trading at ETX Capital, a London-based brokerage. There are probably about 50,000 CFD investors in Ireland, a nation of about 4 million people, compared with 120,000 in the U.K.’s 63 million population, he said in an interview.

The Irish appetite for the derivatives partly prompted Rundle’s firm to last month take over Shelbourne Markets, a Dublin-based spread betting and CFD firm. Trading volumes should increase by as much as to 5 percent each month, Rundle said.

“It was a quicker way into a market that we see as growing and reasonably key for us,” he said. “There definitely seems to be a feeling of wealth and positivity.”

One reason for the continued popularity of CFDs in Ireland may lie in their tax treatment, Somers at the stock exchange said. While a 1 percent levy is applied on regular stock trades, it doesn’t apply to CFDs.

“You’ve got an incentive to buy that security instead of equities from a tax point of view,” Somers said. “It’s like this is nightmare scenario stuff because people were able to avoid stamp duty.”

To contact the reporters on this story: Joe Brennan in Dublin at jbrennan29@bloomberg.net; Donal Griffin in Dublin at dgriffin10@bloomberg.net

To contact the editors responsible for this story: Heather Harris at hharris5@bloomberg.net Anthony Aarons

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