JPMorgan, UBS Offer to Unwind Milan Swap to Curb Trial Damages

Four banks charged with defrauding Milan with derivatives offered to unwind the swap at a discount and pay the city its profit from the transaction under a proposed settlement with the municipality.

According to a draft agreement drawn up by the city administration, JPMorgan Chase & Co., UBS AG, Deutsche Bank AG and Depfa Bank Plc will reverse the deal for 63 million euros ($84 million). The banks will cut that fee to 23 million euros and pay Milan its 476 million-euro mark-to-market gain on the swap, according to the papers seen by Bloomberg News.

In return, Milan will drop its claims for damages from the banks a prosecutor accuses of tricking the city into buying the swaps by hiding the fees they reaped from the trade. The banks won’t admit any responsibility as part of the settlement on the 30-year swaps, and will ask a court to return funds seized during the criminal proceedings, the document shows. The agreement is pending final approval by both sides.

“A transaction of this kind eliminates the financial damages that the banks might have to pay if they were convicted, and it may lessen the sanctions that could include being barred from doing business with certain clients,” said Alessio Lanzi, a criminal lawyer in Milan, who is not involved in the case.

The government is “satisfied” with the reduction in costs, according to the document. Officials for the city declined to comment, as did spokeswomen for UBS, Deutsche Bank, JPMorgan and a spokesman for Depfa.

Hidden Fees

The lenders charged 101 million euros in fees for arranging the derivatives that adjusted payments on the city’s 1.7 billion-euro bond offering in 2005 and from subsequent restructurings, according to city prosecutor Alfredo Robledo. That the fees weren’t disclosed makes them fraudulent, he said as he secured charges against the banks in March 2010.

The banks said in court that firms don’t typically disclose what they’re charging municipalities to arrange swaps, tailored trades that lack comparable market prices.

“Every time I sold a derivative to a public administration, even before getting to the details, the first question was always, ‘How does the bank make money?’” Antonia Creanza, a JPMorgan Chase banker, told the court in September under questioning by her lawyer. “I would explain that we would retain a margin. Never has a legal adviser told me, ‘Look you need to detail the gross margin,’” she said.

Under the agreement, the city will commit to not describe the deal as the reimbursement of the alleged “implicit costs” of the original transactions, and the banks will drop a suit at the High Court in London.

‘Reasonable Rate’

The firms say raising the cash to fund the payment to Milan will cost about 53 million euros, according to the document. The other costs are linked to hedging the swaps. UBS expects to charge the least, at 8.9 million euros, and Deutsche Bank, at

24.5 million euros, the most.

“The costs reflect a funding gap for which the banks appear to be charging at a reasonable rate,” said Jacopo Ceccatelli, founder of JC & Associati SIM, a Milan-based financial advisory firm.

Milan plans to place about 138 million euros of the cash it will receive from the banks in U.K. deposit accounts with the four firms on which it will earn interest equal to 3-month Euribor, the filing shows.

The city will also invest about 275 million euros in Italian government bonds which it will be free to buy through other intermediaries, according to a person with knowledge of the settlement proposal who declined to be identified because the agreement isn’t final.

The cash and bonds will be pledged as guarantees for swaps that the municipality still retains with the banks. Milan sold the banks a credit-default swap on Italy, a transaction on which the city is losing about 206 million euros, the filing shows.

The municipality, which claimed that it had relied on the banks’ advice in arranging the swaps in 2005, says it’s now acting independently based on its own assessment of the risks, according to the term sheet. The city will seek prior approval from the Treasury.

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