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Another German Sub-Prime Hedge Fund Casualty

by Carla Johnson, Investors, London

28 August 2007

The US sub-prime loan crisis claimed a further European scalp earlier this week when German bank Sachsen LB was rescued by another state-owned bank, Landesbank Baden-Württemberg, which provided an immediate Euros 250m in liquidity, and will acquire Sachsen for a consideration of up to Euros 600m, although the deal may yet unwind if Sachsen uncovers further liabilities.

Like companion German credit institution IKB, which was bailed out by German public-sector bank Kreditanstalt Fur Weideraufbau to the tune of Euros 8bn earlier in the month, Sachsen had invested in what are known as 'SIV-lite' funds, which specialize in selling short-term commercial paper in order to buy mortgage securities.

Sachsen's problems centred on Irish affiliate Synapse, which is said to have invested as much as Euros 27bn in high-risk securities, including many based on US sub-prime loans. British bank Barclays investment banking arm, Barclays Capital, which set up funds for Synapse, pulled the plug on Synapse and Sachsen last week when they couldn't meet cash calls, reclaiming collateral.

Edward Cahill, Barcap's head of European collateralised debt obligations, who is said to have helped design the SIV-lite debt structure, resigned last week, and Barclays is thought to be facing a loss in the low hundreds of millions of Euros as a result of Sachsen's demise.

UK law firms, like their fellows in the US, are reporting approaches from hedge fund investors who believe that the funds may have failed in their duty of care towards investors, and possibly have been outright negligent.

US law firm Morrison & Foerster, prominent in investor class actions, warned clients recently that out of today's 9,000 hedge funds, as many as 2,000 are perceived to be vulnerable to “run on the bank” investor redemption pressures. Suspect asset classes, said the firm, include credit default swaps, collateralized debt obligations, collateralized loan obligations, leveraged buyouts, and other distressed debt and exotic categories.

Knowing what is coming, the firm says that investors should consult relevant experts soon, while there is still time to plan a defensive strategy. Such experts, says the firm, include not only bankruptcy/restructuring lawyers, but other cross-border professionals, who know well the relevant players in the Caymans and other applicable jurisdictions. Such experts also should have three other qualifications:

  • deep experience in the prior Drexel junk bond and S&L crises;
  • substantial experience with Chapter 15 bankruptcies; and
  • the experience of working with the other relevant practice specialties on actual hedge fund failures, both in and out of bankruptcy court.

Similarly experienced and connected litigators, hedge lawyers, international tax lawyers, and derivative lawyers are also essential to the process.

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