Barclays suffers derivatives case setback

Barclays breached its duty of care when it sold a rival German bank controversial credit derivatives which subsequently plunged in value, the High Court heard yesterday.

Barclays breached its duty of care when it sold a rival German bank controversial credit derivatives which subsequently plunged in value, the High Court heard yesterday.

In a pre-trial hearing in advance of the case coming to court next year, HSH Nordbank said that the decline in the value of the derivatives had largely occurred through Barclays' mismanagement of the debt portfolios and its decision to include junk bonds within them. HSH lost an estimated $250m (£129m) on $571m worth of collateralised debt obligations, or CDOs as they are known, which it bought from Barclays Capital in 2001. It is claiming that Barclays mis-sold the CDOs and then mismanaged them once the transaction had taken place.

Barclays denies the allegations and says that the fall in the value of the CDOs was largely the result of market conditions. It says HSH's claim is "totally without foundation".

The trial is scheduled to begin on 21 February and last for eight days. If the case gets to court it will cast the spotlight on one of the more controversial and esoteric instruments traded between big City banks.

CDOs are essentially portfolios of credit risk which are packaged together and then sold to investors in tranches, which are priced according to the risk of default. They were once described as "toxic waste" by the former chairman of the Financial Services Authority Sir Howard Davies. They are also known as "Russian dolls" because one CDO often contains investments in other CDOs.

The HSH case involves a $151m investment it made in one CDO marketed by Barclays called Corvus. HSH says that this particular CDO had investments in many other Barclays CDOs. It also says that Barclays dumped credit risks such as exposure to aircraft leases, emerging market debt and telecoms bonds into Corvus three weeks after the 11 September attacks.

When the Corvus CDO was sold to HSH it had investment grade ratings ranging from triple A to triple B. It is now junk rated.

At yesterday's pre-trial hearing, the court agreed that Barclays had a wider duty of care to its client and had a obligation to act in good faith as opposed to merely observing the strict terms of the contract. The court also ruled that any damages which might be awarded to HSH could reflect not just the losses suffered when its investments were marked to market but the loss suffered by not having invested the money elsewhere.

It would be unusual for a case such as this to reach court. Barclays has settled out of court with other investors in Corvus.