City Risks

Pay Up, UBS

119197947 Leipzig DPA
Picturesque Leipzig escapes a big financial crisis bill - for now. Source: DPA

Things just almost got very pricey indeed for the German city of Leipzig. A London court ruled in its favor on Monday in a long-standing dispute with the Swiss investment bank UBS. If the verdict had gone the other way, the city could have faced a bill for €500 million ($590 million), including lawyers’ fees and interest payments.

The British court ruling said the Kommunalen Wasserwerke Leipzig, or KWL, which supplies water and sewage services in the eastern German city, does not owe the bank money as part of complex derivative products it bought before the 2008 financial crisis. UBS immediately announced that it would appeal the verdict to the UK Supreme Court. The bank was disappointed by the judgment, said a spokesperson.

UBS isn’t entirely wrong to be disappointed in the ruling. While it’s certainly likely that some cities were hoodwinked by their bankers in the 2008 crisis – indeed some 800 local German authorities concluded similar deals – that wasn’t entirely the case with Leipzig. There was at least one member of city’s water supplier who knew exactly what was happening at the time.

To celebrate the lucrative deal, the brokers went on safari in South Africa with a number of UBS bankers.

In 2006 and 2007, using the Internet code name “Projekt Matilda,” UBS investment bankers sold the Leipzig water utility four packages of collateralized debt obligations (CDOs), at a total price of €350 million. At the time, the opaque financial instruments were advertised as a form of insurance for sewage treatment plants. However, it later emerged that UBS had concealed bad loans in the packages, including from the US investment bank Lehman Brothers (which famously collapsed in September 2008) and Kaupthing Bank of Iceland.

The deal was arranged by two brokers at the Value Partners Group in Zurich. Via an account in Liechtenstein, they paid €3.5 million to Klaus Heininger, then the KWL managing director, who arranged to keep the deal from the eyes of KWL’s board. To celebrate the lucrative deal, the brokers went on safari in South Africa with a number of UBS bankers. Mr. Heininger and the two Swiss brokers were later convicted of bribery and corruption by a German court, which sentenced them each to several years in prison.

Since the financial crisis, it has been up to the London courts to decide who was responsible for the losses – worth millions in euro – caused by the deal. UBS sued for full payment of the amount owed by KWL. The city of Leipzig refused, arguing the deal was invalid, since UBS and Value Partners had had an “inappropriate” relationship.

The London judgment is the second time Leipzig has won out in court. With it, the Appeal Court confirmed an original judgment of the High Court in December 2014, which said KWL was right to refuse any responsibility for the losses, since UBS had been negligent in its management of the portfolio and was liable. Even if it could not be proved whether UBS knew about the bribery, it had known about the conflict of interest of the two Swiss brokers, ruled the High Court.

The judgment was passed by a two-to-one majority. Lady Gloster, one member of the three-judge panel, departed from the majority verdict on several key points. It was, she argued, “unrealistic” to make UBS responsible for the bribery that took place.

Leipzig’s mayor, Burkhard Jung, said he was very happy: “The judgment is another resounding slap for UBS,” he told the Leipziger Volkszeitung newspaper. “If UBS took their own moral principles seriously, they would now withdraw the case,” he added. Perhaps a bit of introspection for Leipzig wouldn’t hurt in this case, either.

Carsten Volkery is Handelsblatt’s London correspondent. Brían Hanrahan adapted this story for Handelsblatt Global. To contact the author: volkery@handelsblatt.com

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