Barclays faces call for City inquiry over German bank's losses

Barclays Bank is set to become the subject of an official complaint to the main City regulator after investors lost hundreds of millions of pounds on controversial credit derivatives sold by the bank just as the dot.com bubble began to burst.

Barclays Bank is set to become the subject of an official complaint to the main City regulator after investors lost hundreds of millions of pounds on controversial credit derivatives sold by the bank just as the dot.com bubble began to burst.

The German bank HSH Nordbank, which has an exposure of $571m (£312m) to the complex debt instruments marketed by Barclays, has already launched a High Court action for damages against the British bank and is now considering lodging a formal complaint with the Financial Services Authority.

HSH claims it was mis-sold the products, known as collateralised debt obligations (CDOs), and that Barclays then mismanaged its portfolio of CDOs in a way which further damaged the interests of investors. Barclays also stands accused of "short-selling" the CDOs for its own commercial benefit.

Barclays said last night that it would "vigorously defend" the action, saying the allegations made by HSH Nordbank were "totally without foundation". A spokesman added: "We remain comfortable that these investments were not mis-sold."

The CDOs marketed by Barclays Capital were put together in New York but they were sold to investors through its London operations. The team that sold them included some of the Barclays Capital bankers who infamously spent £44,000 on dinner at Gordon Ramsay's Petrus restaurant in July 2001 to celebrate pulling off a deal. Manish Chandra, a structured derivatives analyst at Barclays Capital, picked up the lion's share of the bill, which included a bottle of 1947 Chateau Petrus costing £12,300 and a tip of more than £1,000. Five of the six bankers at the dinner subsequently left Barclays because of the torrent of bad publicity caused by the episode. Mr Chandra resurfaced a year later at BNP Paribas.

Although the court action brought by HSH concerns only a $151m investment in one Barclays CDO, estimates of the total amount that the German bank has lost are put at about $250m. Another investor which lost money, the European Bank for Reconstruction and Development, is understood to have settled with Barclays.

Internal HSH documents concerning the case state that the bank has "to consider that the CDO system was created to either dump assets from Barclays balance sheet into its customers' portfolios or to make huge profits at the expense of its investors".

The court case revolves around a CDO which Barclays marketed in December 2000 called Corvus - one of about 16 CDOs with a face value of $15bn launched by the bank over a two-year period. HSH took a stake of about 30 per cent in Corvus.

The internal HSH documents show that the bank is particularly concerned about a series of "unusual trades" involving the Corvus portfolio carried out on 28 September 2001 - less than three weeks after the terrorist attacks on New York and Washington. On that day Barclays injected a range of credit risks into Corvus which had the effect of significantly increasing its exposure to aircraft leases, emerging market debt and distressed telecom companies such as Global Crossing, Lucent and Marconi. In one transaction, $14.5m of Global Crossing notes were substituted into Corvus giving it an exposure to the company of $66.9m compared with a maximum of $35m under the guidelines for that particular portfolio.

According to HSH, the danger to investors was compounded by the fact that Corvus also held cross-shareholdings in other Barclays' CDOs with high levels of risky exposure.

"By any measure, the trading strategy looks extraordinary and we are greatly concerned about what Barclays intended to achieve," the HSH document says. It goes on: "It is clear these substitutions on 28 September were contrary to the interests of Corvus noteholders."

When Corvus was launched, the top three tranches of the portfolio were given investment grade ratings of AAA or AA by the credit agency Fitch. By September 2003 they had been relegated to junk bond status while other tranches, also with investment grade ratings, had been downgraded even further.

HSH claims that the way the portfolio was actively managed ran counter to Barclays' own marketing material which boasted that the bank was "able to sell potential credit problems well before a default occurs".

The German bank said it had no intention of backing down from its legal battle with Barclays and had set aside enough resources and staff to fight the groundbreaking case for the next five years if necessary. The High Court has set down six days to hear the case next February. HSH has retained Christopher Carr QC to represent it and intends calling the head of Barclays Capital, Bob Diamond, to give evidence.

Barclays is expected to argue that the losses suffered by HSH were due to one of the worst downturns in the credit market in decades. Another key plank of its defence is likely to be that the German bank was not only a sophisticated investor but was involved in structuring the CDOs itself.

See Jeremy Warner's Outlook