Barclays takes US$125m derivatives hit on failed Advent deal

IFR 2418 - 29 Jan 2022 - 04 Feb 2022
5 min read
Christopher Whittall

Barclays lost about US$125m on a complex currency derivatives trade in December linked to Advent International and Singapore wealth fund GIC’s abortive takeover attempt of drug maker Swedish Orphan Biovitrum, according to sources familiar with the matter, delivering a blow to recently appointed chief executive CS Venkatakrishnan and his reputation as a sound risk manager.

Deutsche Bank and Morgan Stanley also lost about US$20m apiece after UK pharmaceutical firm AstraZeneca effectively blocked the SKr69.4bn (US$7.5bn) buyout offer from private equity giant Advent and GIC for the Swedish biotech company also known as Sobi, the sources said.

All three banks had provided a type of derivative called a contingent option that allowed Advent to lock in the exchange rate on a large chunk of the Sobi acquisition ahead of time, with the additional flexibility of allowing the firm to discard the hedge for no fee if the deal failed to close. Barclays held the largest exposure from the hedge, which was worth roughly US$3bn in total, one source said. The Swedish krona declined about 6% against the dollar in the three months between the announcement of the proposed Sobi acquisition in early September and its collapse, leaving the banks exposed to a sizeable FX move.

Barclays, Deutsche Bank, Morgan Stanley and Advent all declined to comment. GIC did not respond to a request for comment.

The scale of Barclays’ losses represents a black eye for Venkatakrishnan, a former risk manager who famously led a team that flagged the notorious “London Whale" credit derivative trades that inflicted around US$6bn of losses on his former firm JP Morgan. “Venkat”, as he is also known, headed Barclays’ global markets division prior to taking over the top job from Jes Staley in November and would almost certainly have had to sign off on the Sobi deal contingent trade, given the size of the position.

Barclays had looked to ramp up its presence in deal contingent options significantly last year and became known for pushing more aggressive deal terms. The UK bank is now considering scaling down its presence in contingent options following the Sobi losses and has been looking to reduce its risk in other positions it holds, sources said.

Rapid expansion

The market for contingent options expanded rapidly last year amid record dealmaking activity with the announcement of US$2.1trn of cross-border mergers and acquisitions (a nearly 70% jump from 2020). That provided an important source of revenue for many bank trading desks in what was an otherwise sleepy FX market. Many banks favoured offering contingent hedges for PE-led takeovers, which historically have had a better track record of completing compared with corporate M&A, and industry veterans reported increasing signs of frothiness in this corner of the market last year.

All this came against the backdrop of a 25% increase in average deal sizes to US$119m in the PE space, forcing banks to take down more risk – or share deal contingents out among rivals. Last year also saw a steep increase in PE deal failure rates for cross-border M&A to 18% – more than four times above the previous year and the highest level since 2016.

That didn't stop deal contingent premiums – which are typically quoted as a percentage of the cost of a regular FX option – decreasing to between 20% and 25% of the equivalent option on many deals (or even below that range in some cases) as banks competed fiercely to win these trades despite an abundance of opportunities.

In the most widely used type of structure, the deal contingent premium gets added on top of the forward FX rate to account for the extra leeway the client has to walk away from the hedge if the deal collapses. So the lower the premium, the cheaper the hedge. (The premium is only a fraction of the cost of a regular FX option because the acquirer can only drop out of the contract if the underlying deal falls through.)

The contingent premium on the Sobi contingent options was around 30%, sources said. While higher than on other deals, some industry experts say it was still far too skinny given the potential for disruption to the blockbuster buyout. Possible snags included certain conditions set out by Sobi’s largest shareholder, Investor AB, as well as AstraZeneca using its own stake in Sobi to block the takeover.

The size of the Sobi deal left banks – and Barclays in particular – vulnerable after exchange rate moves. Morgan Stanley managed to place some hedges to limit its losses on its portion of the hedges, sources said. Deutsche Bank often keeps its exposure on individual contingent trades quite small to help it better absorb losses when a transaction falls through, sources said.