It appears banks being sued by irate clients who bought derivatives contracts and lost money on them is not limited to this country. Divania, Italy’s tenth largest exporter, is suing Unicredit, Europe’s second largest bank, for fraud and usury, for having been sold derivatives contracts that lost money, forcing the $100-million company to shut down.

A similar scene is playing itself out here; several Indian companies are taking matters to the courts — Sundaram Multipaper is suing ICICI Bank, for one — about being similarly fooled; ICICI Bank says that the company knew what it was getting into.

Media reports have named Yes Bank and Kotak Mahindra Bank as other banks that ‘mis-sold’ such derivatives contracts to unsuspecting companies. The Reserve Bank of India (RBI) has received complaints from other companies too that say were misled by the banks. While some have alleged misrepresentation, others say that these deals were not approved by the appropriate authority, often the board of directors. “Most companies require board approval for getting a loan,” says a former financial controller at one of the companies. “Given that, taking on such exposures would require similar approvals.” None of the companies and their officials wanted to be named since matters were either sub-judice or in negotiation.

Yet others allege fraud by their own employees, or officials going beyond their remit, who used the hedges as a way of speculating on currency movements. This much seems clear: most of the companies caught in this situation are the small and medium-sized export houses who were struggling with an appreciating rupee and tighter profit margins. “Many of these companies may have immature corporate governance structures,” says Mohandas Pai, former CFO at Infosys Technologies. “They may not have risk management capabilities at the board level that could review these transactions or be advised of the downside risks.”

Many of the companies affected are based in the south, where financial conservatism rather than aggressive behaviour is the norm. “So when approached by the big Mumbai banks, they may have succumbed,” says a former CFO of a Bangalore-based export firm. “Besides many of these companies need the banking relationships that large banks can provide, and that may have been another reason for being intimidated into undertaking these deals.”

According to RBI guidelines, companies can hedge using derivative contracts in line with the value of the underlying trade transaction or export. But it seems that in many cases, the positions implied by the derivatives contracts were several times the value of the underlying export, making it a speculative bet on currencies, and a large one at that. “There have been instances when a bank has sold a company a derivatives position, and gone ahead and taken the exact opposite position on its own account,” says the CFO of another Chennai-based export house.

Doth the victim protest too much? Some companies have gone ahead and bitten the bullet, but for the others, there are three defences: the deals were entered into by people not authorised to enter into them, full disclosure about the downside risks was not forthcoming, and even the banks had to know that the positions being taken were in violation of RBI prudential norms by being several times the underlying export transaction. That’s for the courts to decide, however, or for the banks and companies to negotiate a settlement.

Divania’s owner Francesco Saverio Parisi had another weapon: secret videos of Unicredit officials softening him up for the kill. Some videotapes of the meetings with the bank advisors showed how the bank manipulated documentation; one tape even had a Unicredit advisor admitting that he knew little if anything about the nature of the contracts he was asking Parisi to sign. Parisi is suing for almost $450 million. Banks may discover a new twist to the meaning of the word ‘payback’.

Source: http://www.businessworld.in/content/view/3680/3779