(March 6, 2013) — Investors with long investment time horizons should consider taking on the risk of some banking units, a private equity partnership has claimed.
World Trade Capital Partners told attendees at the National Association of Pension Funds (NAPF) Investment Conference in Edinburgh this morning that they could take advantage of the regulatory pressure being applied to the banking sector through equity investment.
Remy Kawkabani, partner at the firm and former head of European distribution for Credit Suisse’s asset management business, told attendees that banks had a shortfall of over €2.5 trillion on their Basel III capital requirements. Instead of helping banks shrink their balance sheets by buying up loans cheaply, which has been the main trend in recent years, investors could effect a “risk transfer” arrangement that would function as an equity investment.
Investors would commit capital to a specific unit of a bank–in this case trade finance–and act as guarantor should that unit make a loss. The capital would be held in US treasuries in a separate custodian account and only touched if a drawdown event occurred, Kawkabani said.
This way, the bank’s own capital could be spread throughout the rest of the bank to try and meet the higher demands made by the Basel III regulation. Trade finance units have seen their capital requirements increase by up to a factor of 10, the firm said, as regulators considered banking units across the board to be inherently more risky after the crisis.
This week, the Abu Dhabi Investment Authority lost its appeal to overturn a judgement made in a case it brought against Citigroup. The Middle Eastern fund claimed Citigroup had mismanaged some of the $7.5 billion it had committed to the bank during the financial crisis, which had helped keep the bank afloat.
World Trade Capital Partners said investors had complete control over which underlying portfolio units they would back, and would be paid upfront for the facility. The design of the investment also meant investors should be insulated from losses made in other parts of the bank.
Last week, it was revealed that Citi and private equity firm Blackstone had agreed a deal that saw part of the bank’s shipping loan book effectively insured through a similar risk transfer agreement.
All deals would have to be agreed by country regulators as they would have to agree to the capital passing muster, the Kawkabani, adding that the UK’s Financial Services Authority and the Dutch National Bank had already agreed in principle.
Kawkabani claimed investors could be in line for returns with an equity-like risk profile–between 13% and 18% and was uncorrelated with other asset classes.
For an in depth look at new investment thinking, see the March/April edition of aiCIO.