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Hedge funds getting paid to share Banks' financial risk without investor knowledge

Chenavari Investment Managers, has established a formidable reputation as an investor, Bloomberg Markets magazine will report in its October issue.

Chenavari is one of a handful of firms that invest in capital relief trades, or CRTs. A bank pays a third party, such as a hedge fund or pension fund, to take on some of the risk associated with its loans. That makes it easier for the bank to meet regulators’ capital-to-risk requirements.

Private Deals

CRTs often involve complex structures in which special-purpose companies are set up to provide protection to the bank through a credit-default swap, a derivatives contract that pays the buyer if a designated bond or loan portfolio defaults, and are in turn funded through the sale of notes to investors.

Before Basel III, banks had to hold only 2 percent in this so-called core tier 1 capital; by 2019, that will rise to 4.5 percent and total capital ratios will have to be as high as 13 percent.
The Basel Committee estimates that 75 of the world’s biggest banks collectively will need to find an additional $300 billion in core capital to meet the new requirements.
The growing need for capital has made banks enthusiastic partners in CRTs. Citigroup Inc., Commerzbank AG, Credit Suisse Group AG, Deutsche Bank AG, Lloyds Banking Group Plc, Standard Chartered Plc and UBS AG are among the dozens of banks that have engaged in the capital-saving deals during the past four years, according to their regulatory filings.

Absorbing Risk

One advantage to CRT deals, advocates say, is that hedge funds rarely threaten the overall financial system. These funds generally weathered the 2008 financial crisis better than banks; none required a government bailout.
In return for absorbing part of the banks’ default, counterparty or correlation risk, investors such as Fery’s Chenavari can make annual returns as high as 15 to 20 percent on each deal.

http://www.bloomberg.com/news/2013-09-12/banks-allying-with-hedge-funds-as-capital-rules-bite.html

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