Cassa Di Risparmio Della Repubblica Di San Marino v Barclays Bank Ltd

On 9 March 2011, Hamblen J handed down his Judgment in Cassa di Risparmio della Repubblica di San Marino SpA v Barclays Bank Ltd1. The case concerned a misselling claim brought by San Marino against Barclays in relation to the portfolio composition of a complex financial product.

Barclays constructed and sold to San Marino four sets of structured notes (the Notes) which had embedded within them credit derivatives known as collateralised debt obligations (or CDOs) which gave exposure to the credit risk of a portfolio of reference assets through a portfolio credit default swap. The reference assets in turn included further CDOs, each of which was in turn referenced to another portfolio of some 50 credit default swaps, so-called “CDO squared”.

San Marino claimed that it was induced to buy the Notes, and to agree to a subsequent restructuring, by misrepresentations which were either fraudulent or negligent. This Bulletin considers San Marino’s claim in fraudulent misrepresentation relating to Barclays’ alleged ‘credit ratings arbitrage’

Fraudulent misrepresentation

A claim in fraudulent misrepresentation is normally labelled as “fraud” but is, in formal terms, the tort of deceit. As stated in Clerk & Lindsell on Torts2:

“The tort [of deceit] involves a perfectly general principle. Where a defendant makes a false representation, knowing it to be untrue, or being reckless as to whether it is true, and intends that the claimant should act in reliance on it, then in so far as the latter does so and suffers loss the defendant is liable for that loss.”

Silence by itself cannot found a claim in misrepresentation. However, an express statement which is literally true may impliedly represent something because of matters which the representor omits to mention. For example, in Oakes v Turquand3, an old case about statements made in a company prospectus, Lord Chelmsford said:

“… it is said that everything stated in the prospectus is literally true, and so it is; but the objection to it is, not that it does not state the truth as far as it goes, but that it conceals most material facts with which the public ought to have been made acquainted, the very concealment of which gives the truth which is told the character of falsehood.”

The onus is on the claimant who alleges fraud to prove a lack of honest belief on the part of the representor. It is plainly therefore not a straightforward claim and one which requires detailed analysis and a full understanding of the context in which representations have been made.

Credit ratings arbitrage

Barclays was accused by San Marino of ‘credit ratings arbitrage’. Credit ratings arbitrage involves taking advantage of two features of the methods by which the rating agencies assessed the risk of default in a CDO squared.

First, rating agencies looked at historical default rates to estimate the probabilities of default of the CDO reference entities. Meanwhile, credit derivative traders use credit spreads to estimate the probability that companies will go bust in the future. The historical default rates take no account of current circumstances and expectations. There was also an invariable delay between the deterioration of a particular credit and any subsequent ratings downgrade.

Second, rating agencies did not estimate the probability of default on each reference entity individually. Instead, they simply looked at their own credit rating for the entity and then assumed that its probability of default was the same as the overall default rate for all entities in that rating category. Clearly though, as the credit spreads demonstrate, there is a spectrum of risk within the same rating.

The arbitrage appears when traders bundle debt and slice it in the form of CDOs. Conservative investors bought these products on the basis of AAA credit ratings, accepting a low return in exchange for safety. However, bankers designing CDOs could profit from the difference between the ratings of the assets and their market price.

According to analysis presented by San Marino, the AAA credit rating of the Notes implied a probability of default of less than 1%. Meanwhile, the credit spread approach used internally by Barclays suggested (it was alleged) a default probability of more than 25%.

Accordingly, San Marino said that at the same time as selling the CDO squareds to San Marino on the basis of its AAA rating, Barclays was deliberately structuring the CDO squareds in such a way that they had, on Barclays’ own calculations, a very substantial risk of default. San Marino said that this was demonstrated by Barclays’ own internal emails.

San Marino said that Barclays deliberately selected for inclusion in the reference portfolios entities within each category at the top end of the range of risk by including entities with high spreads for their ratings. The effect was to skew the risk profile upwards. San Marino contended that it bought products which paid a return of 1% over Euribor, believing them to be a secure investment, when on Barclays’ calculations it was alleged the return which would have been necessary to compensate for the actual risk of default was of the order of 5% over Euribor, equivalent to the rate payable on a ‘junk’ bond.


San Marino was unsuccessful on its claim. The judgment is long but the headline points are as follows.

The judge accepted that Barclays deliberately selected for inclusion in the reference portfolios of the CDO squareds entities which had high spreads for their ratings:

“It is not conceivable that the concentration found by the experts of names with high spreads for their ratings could have occurred other than by design.”

The judge also acknowledged that Barclays must have regarded the data from its pricing model, derived from credit spreads, as sufficiently certain to meet the accounting standards of revenue recognition to justify net profits being reflected in their accounts.

However, although the judge recognised that the pricing model used by Barclays could be used reliably to estimate its profits, he - perhaps surprisingly - held that the pricing model could not be used to estimate longterm default risk. Given that the judge acknowledged that Barclays’ pricing model estimated its net profits by reference to the probability that the investor would not be paid back at the end of the relevant period, ie the default risk, it is difficult to follow the reasoning. The transaction worked on the basis that Barclays’ profit was directly equal to the amount of San Marino’s estimated loss.

Further, the judge’s analysis was that the rating agencies’ use of historical defaults was a more accurate guide to the possibility of default than the market’s present assessment via credit spreads. That is also, on the face of it, a surprising finding.

On the basis that credit spread derived figures are not reliable, the judge held that it was reasonable and justifiable for Barclays to take advantage of the difference between such figures and the price reflective of the default risk implied by rating agencies. Further, he held that it was also reasonable and justifiable to take full advantage of the arbitrage opportunity provided by accentuating that difference through the selection of reference entities with high spreads for their ratings. In pushing up its profits in this way, the judge held that Barclays had an honest and reasonable view that there was not an equivalent or high ‘real world’ probability of default.  

The judge also considered that to find against Barclays would potentially undermine the practices of the banking market:

“The evidence showed that it was the very basis of the CDO business to make an arbitrage, buying protection at spreads which meant that Barclays would make a MTM profit on the CDO. Further, the evidence was that it was common for banks to make profits thereby of the order of more than 10%”.

Finally, the judge held that contracts between banks for the sale and purchase of complicated structured products work perfectly well on the basis of the principle of caveat emptor. He considered that the buyer is meant to make his own assessment of the risks of the transaction and to make an independent decision as to whether to enter into it.


There can be no doubt that many investors will be surprised by the judge’s conclusion on the basis of the CDO business. The manipulation of portfolios by banks to maximise their profit but increasing the corresponding risk to investors while maintaining the credit rating that their clients were seeking is a matter of increasing concern to investors, many of whom were sold investments on the basis that the skill of the structuring banks would be used to their advantage.  

Indeed, investors will struggle to understand why this case was distinguished from Oakes v Turquand. Barclays understood that San Marino wanted the Notes to have a AAA rating and that they therefore wanted an asset with a low default risk. In such circumstances San Marino no doubt consider it material that Barclays, on its pricing model, was pushing the estimated risk of default as high as possible within the boundaries set by a AAA rating to maximise its profits. It is unlikely that San Marino would have purchased the Notes if it had known what Barclays was up to.

The case is one of a series of recent cases in England relating to the misselling of financial products which have favoured investment banks. Investors who have suffered dramatic losses on products sold as low risk will obviously be concerned to see whether the Commercial Court in particular will in future pay sufficient regard to the substantial asymmetry of information and sophistication which in reality exists between the Arranging Banks and those institutions with which they deal.