Riccardo Banchetti, whose work packaging derivatives at Lehman Brothers Holdings Inc. got him the top European job at the firm a week before it failed, is now making a living unraveling the kind of deals he once developed.
Banchetti worked with Banca Monte dei Paschi di Siena SpA to uncover 730 million euros ($955 million) of losses that the world’s oldest bank hid through the use of derivatives. The Italian banker, who also advised JPMorgan Chase & Co. on its defence against fraud charges over swaps with Milan, has scrutinized more than 10 billion euros of transactions since leaving Lehman, according to a person with knowledge of his activities who asked not to be identified because they weren’t authorized to speak publicly.
As municipalities, governments and companies added to their borrowings in the years leading up to the financial crisis, investment banks profited by devising opaque, tailored trades to allow clients hedge their bets, adjust payments and at times free up even more cash. Years later, those transactions, often too complex for customers to understand, are pitting securities firms against their clients as losses lead to court cases and growing demand for expert advice.
“Derivatives lawyers and advisers have been kept busy by advising banks on accounting-driven restructurings of complex derivatives transactions,” said Nigel Dickinson, a derivatives lawyer at CMS Cameron McKenna in London. “It’s in an environment where there continue to be relatively few ‘new money’ deals.”
Banchetti, 46, declined to comment for this article. Officials at New York-based JPMorgan and Siena-based Monte dei Paschi also declined to comment on his role.
Banchetti’s firm, Eidos Partners Holdings Ltd., helped Monte dei Paschi reveal how three deals, dubbed Santorini, Alexandria and Nota Italia, obscured the bank’s true accounts and hid previous losses. He wasn’t involved in structuring the initial transactions.
Santorini, first revealed by Bloomberg News on Jan. 17, allowed the Italian lender to borrow about 1.5 billion euros from Deutsche Bank AG, enabling it to replace an earlier derivative that had backfired. In return, Monte Paschi made a money-losing bet on the value of Italian government bonds and last month said the three deals wiped 730 million euros of its assets.
The bank in January paid 139 million euros to restructure Nota Italia, the Italian lender has said, reducing its exposure to potential losses on Italian government bonds. JPMorgan Chase & Co. arranged the original transaction, according to two people familiar with the transaction. Officials at the New York-based firm declined to comment.
Santorini and Alexandria are now the subject of criminal probes as Siena prosecutors investigate alleged market manipulation and false bookkeeping by Monte Paschi’s former management, according to court officials.
Monte Paschi received 4.1 billion-euro bailout on Feb. 28 and the following day sued Deutsche Bank and Nomura Holdings Inc., as well as its own former managers, over Santorini and Alexandria. Officials for Deutsche Bank and Nomura in London both declined to comment.
Banchetti has worked in derivatives for more than 20 years and Italy is the market where he has the most experience. It took the 15-year Lehman veteran just six months to reinvent himself as derivatives adviser focusing on the Italian market. Together with fellow Italian national Antonio Miele, a former derivatives banker at Nomura, Banchetti founded Pactum Advisers in March 2009.
From Pactum’s office in the heart of the fashion district of Milan, nestled in a palazzo adorned with frescos that contrast with wall-to-wall modern art fixtures, Banchetti has attracted clients including pension funds and municipalities seeking advice on derivatives gone sour.
In 2011, he added to Pactum’s activities, buying Eidos Partners, an advisory firm that focuses on mergers and initial public offerings. Banchetti, who is regulated by Britain’s Financial Services Authority, is the biggest shareholder of Eidos, as the combined business is called, which now employs about 30 consultants and in London and Milan. Its most recent commissions include advising London-based private equity firm CVC Capital Partners Ltd. on its 1.1 billion-euro purchase of Cerved Group, an Italian provider of company information.
In swaps like those the city of Milan entered, two parties agree to exchange securities or payments, such as interest charges, on a notional amount of debt. That allows the borrower to lock in terms it might not be able to get on the open market.
His past work in structuring derivatives could still taint his objectivity, said Christopher “Kit” Taylor, a former executive director of the Municipal Securities Rulemaking Board in the U.S., the national regulator of the municipal bond market.
“The question is how tough and straight is his opinion going to be?” said Taylor. “You wouldn’t want anyone close to past transgressions who wouldn’t want to lose the connections to the community they came from.”
After trading for Bankers Trust, Banchetti joined Lehman’s fixed-income derivatives operation in 1993. At Lehman, Italian colleagues included Bernardo Mingrone, who became Monte Paschi’s chief financial officer in June.
Banchetti took over the running of the fixed-income unit in Italy in 2002, and a year later moved to London to co-head the bank’s European fixed-income business. In 2006, he returned to Italy as chief executive officer of the business and became co-CEO for Europe a week before the firm filed for bankruptcy.
Banchetti’s shaping of Lehman’s fixed-income business meant he was one of the top dozen bankers who helped build the U.S. firm’s European activities, according to a person familiar with company. By the bank’s peak years of 2006 and 2007, his unit was generating about $3 billion in sales out of a total of just less than $7 billion for Europe, said the person, who asked not to be identified because the information was never publicly disclosed.
Banchetti has filed to recover $26 million in compensation he forfeited when the firm filed for bankruptcy in September 2008, filings show.
He is now taking advantage of a dearth in local specialist advice in tackling complex derivatives, say lawyers and consultants who have advised clients on swaps. Customers often don’t have the expertise internally and external advisers lack the market knowledge that gives securities firms an advantage in negotiations.
International independent risk advisers, common in the U.K. and the U.S., “simply don’t exist” in Italy, according to Paolo Esposito of Chatham Financial, a U.S. firm that advises clients on interest-rate and currency hedging and worked with the city of Milan on its 455 million-euro swaps settlement with four banks a year ago.
It was a “grave asymmetry of information” that laid at the heart of the fraud four banks committed when they sold interest-rate swaps to the municipality, judge Oscar Magi wrote on Feb. 4. Magi convicted the firms, including Banchetti’s client JPMorgan and Deutsche Bank, in December for their role in overseeing the fraud by their bankers.
Over the two-and-a-half-year trial that often saw Banchetti attending the weekly hearings as one of the banks’ cluster of advisers, the judge heard from the securities firms that university professors who acted as expert witnesses for the prosecution couldn’t challenge their superior market knowledge. What is standard market practice isn’t what professors teach in textbooks, the banks’ lawyers argued. The banks didn’t admit to any wrongdoing as part of their settlement agreement.
Italians need independent financial advice and markets mustn’t be “demonized,” Banchetti told Radio24 in an interview in November 2011.
Banchetti’s business is poised to benefit as municipalities across Italy review their derivatives contracts following the Milan case. Local governments are losing more than 1.3 billion euros, according to June data released by the country’s central bank.
“What’s the choice?” said Simon Maughan, a banking analyst at Olivetree Securities Ltd. in London. “If there is an issue here, then the solution is in preventing banks engaging in such complicated financial transactions in future. The answer is not in denying Monte Paschi the chance to clean house.”