A decision by Portugal's central bank, which effectively penalizes institutional investors that lent $784 million to a Portuguese bank a month before its collapse in August, could undermine the growing role of sovereign wealth funds in providing liquidity to the global financial system, said Adrian Orr, CEO of New Zealand Superannuation Fund.
On Thursday, the NZ$27.78 billion (US$20.9 billion) Auckland-based fund announced it was joining seven fellow lenders to Lisbon-based Banco Espirito Santo, through a special purpose vehicle arranged by Goldman Sachs & Co., in a lawsuit against the Bank of Portugal.
Mr. Orr, in a Friday interview, said the lawsuit comes after the central bank this week reaffirmed its Dec. 22 decision to transfer the loans from the special purpose vehicle, Oak Finance, out of the new, or good, bank (Novo Banco) which was set up to house Banco Espirito Santo's healthy assets, to the old bank, which holds the non-performing assets.
Bank of Portugal did so on the strength of a law passed Aug. 1, after Banco Espirito Santo's collapse, establishing a 2% equity ownership threshold for “related party” transactions and, applying that rule retroactively, found Goldman Sachs and Banco Espirito Santo to be related parties. Then, deeming the special purpose vehicle loan to the bank as a loan from Goldman, the central bank on Dec. 22 consigned that loan to the bad bank, Mr. Orr said.
Mr. Orr, a former central banker himself, termed the Bank of Portugal's approach “a travesty,” which would pose systemic risks for Portugal's banking system if not reversed.
Goldman Sachs' holdings in Banco Espirito Santo never reached the 2% threshold the central bank retroactively applied, Mr. Orr said. And even if it had, there's no basis for considering a loan made by outside investors to be a loan by Goldman, he said.
The Bank Espirito Santo liabilities related to the Oak Finance loan were not transferred to the new bank due to “serious and well-founded reasons to believe that Oak Finance was acting on behalf of Goldman Sachs International in regard to the loan,” said a Bank of Portugal spokesman said in an e-mailed statement in response to questions.
Explaining the central bank's Feb. 17 decision to reject Goldman Sachs appeal of the initial Dec. 22 finding, the Bank of Portugal statement said the U.S. investment bank's written appeal “did not demonstrate that Oak Finance was not acting on behalf of Goldman Sachs International in regard to the loan that Goldman Sachs International organized, structured and financed, by underwriting securities issued by Oak Finance for the purpose.”
Mr. Orr Friday said New Zealand Super and its fellow lenders in the Oak Finance special purpose vehicle “are the only senior debt holders that have been treated in this manner.” Usually, for regulators tasked with ensuring the health of a financial system, treating senior debt holders differently is a “no-no” on every level, he said.
If that decision stands, for any senior debt holder of Portuguese bank debt, “their ranking is now totally dependent on the future behavior of whoever arranged that debt for them,” Mr. Orr said.
In the e-mail, the central bank spokesman declined to address Mr. Orr's arguments that the Bank of Portugal's actions could result in systemic threats to Portugal's financial system.
New Zealand Super's liquidity provision allocations, which began in 2009 following the global financial crisis, accounted for 2.5% of the fund's total portfolio as of Nov. 30 and roughly 20% of the fund's 12% allocation to fixed income.
In January, after the fund wrote off its US$150 million in Banco Espirito Santo loans, that credit strategy's weight in New Zealand Super's portfolio dropped to 1.8% of an 11% allocation to fixed income.
Mr. Orr said he's confident New Zealand Super will be able to recover those funds eventually through the courts.
The central bank, for its part, suggested a willingness to meet the Oak Finance lenders there, noting in its Feb. 17 statement that “any further doubts may only be clarified in court.”
Mr. Orr said even with writing off the loans, the annualized value added over cash returns by the fund's credit provision strategy over the past five or six years remained positive, at roughly 1.4 percentage points. Before the loans were written off, the program had added value in excess of cash returns of 1.93 percentage points.
Writing off the loans in January has somehow made that program seem exotic and complex, but “it's not,” Mr. Orr said. This type of liquidity provision is at the “simple, vanilla, low-risk end” of the investment spectrum, and with insurance from credit default swaps, which eats up perhaps 1 percentage point of a 2- to 2.5-point return above cash, it counts as a low-risk, low-return investment that makes the financial world go round, he said.
Only the Bank of Portugal's unprecedented move, effectively separating the special purpose vehicle's loans from both the money lent and the credit default swaps bought as insurance, which remain with the good bank, has made that provision of liquidity a risky strategy in Portugal, Mr. Orr said.
“Institutions like ourselves need to be involved in providing liquidity when liquidity is most needed,” because long-term investment horizons enable them to ride out investment cycles, Mr. Orr said. Financial market regulators around the globe should be interested in promoting that kind of activity, he added.