The recent High Court judgment in Cassa di Risparmio della Repubblica di San Marino S.p.A. v Barclays Bank Ltd  EWHC 484 (Comm) will be welcomed by financial institutions who were involved in structuring and selling complex financial products such as collateralised debt obligations (CDOs) prior to the financial crisis. This is one of very few cases involving CDOs to be litigated through to trial in the English courts and has been closely observed by commercial banks and other institutional investors who bore significant losses from CDOs as a result of the financial crisis, as well as by the investment banks involved in arranging or structuring them. The judgment contains a very detailed analysis of the evidence presented to the Court at trial and a thorough examination of the technical and transactional background and the legal issues of misrepresentation, fraud, inducement and reliance, contractual estoppel, and implied terms which arose in the case.
While each case will obviously turn on its own facts, this decision highlights the difficulties sophisticated investors face when seeking to pursue claims based upon allegations of misrepresentation and deceit on the basis of the selling bank's alleged knowledge, or internal assessment, that the default risk of a particular structured investment at the point of sale was far higher than the rating assigned to it by credit rating agencies. The judgment is most obviously of interest to those involved with credit derivatives, but also contains some more general points relevant to contract lawyers and to litigators bringing claims based on alleged fraud.
- Descriptions of, or references in the documentation to, investments as "AAA-rated" will not amount to a general representation as to, or endorsement of, what that rating says about the default risk of the investment. An AAA/Aaa rating is simply a statement by the credit rating agencies of their expert opinion of default probability based on historic default rates, and sophisticated investors should treat the rating as such.
- The principle of caveat emptor retains prominence in the market for structured credit products.
- Credit ratings models utilising historical default data are not comparable to pricing models (used by arranging banks) which are based on credit spreads and reflect what an investor would require by way of return to take on the perceived risk attached to an asset. Pricing models are used to calculate hedges, to mark the assets to market and to assess potential P&L, but not to measure long-term probabilities of default. The valuations and output generated by pricing models cannot therefore form the basis for investor arguments that the arranging bank had knowledge that credit ratings were misrepresentative of the risk of default.
- The practice of 'credit ratings arbitrage', whereby the reference pool of the CDO was created by sourcing assets with the highest credit spreads capable of satisfying the credit rating agencies' methodologies for an AAA rating, was a normal part of these types of trade and was inherent to the CDO business.
- The judgment adds to the established line of cases in which the courts have demonstrated their willingness to uphold arranging banks' no representation and no duty of care disclaimers, where they are properly incorporated and drafted, against sophisticated claimants with the consequence that the claimant can be contractually estopped from pursing a claim for negligent misrepresentation
- The case also illustrates a number of potential pitfalls for claimants seeking to establish fraud as part of their claim.
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