Lisbon is taking court action against Spain's Banco Santander over "toxic" derivatives sold to public companies

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Lisbon is taking court action against JPMorgan and Banco Santander

The government hopes to stem potential losses from complex hedging products

Three other international banks are attempting to reach an agreement with the government

Financial Times  — 

Lisbon is to take court action against JPMorgan and Spain’s Banco Santander over what it says were “toxic” derivatives sold to public sector companies.

The move is part of a government effort to stem potential losses of up to €3bn from complex hedging products.

The allegations in Portugal are similar to cases in Italy, where a court convicted banks of mis-selling derivatives, and the UK, where the “big four” banks have been ordered to review their selling of interest-rate swap contracts.

In Portugal, heavy losses by state-owned companies from derivatives supposed to protect them from rising interest rates would weaken government efforts to keep the country’s €78bn bailout programme on track.

A report, which identifies 57 of 140 hedging products examined as “highly speculative”, is to be sent to the public persecutor, who will decide whether to begin criminal proceedings against managers in the state-owned companies involved.

Maria Luís Albuquerque, Treasury secretary, said the government had decided to take legal action against JPMorgan and Banco Santander Totta, a Portuguese subsidiary of the Spanish group, after two months of negotiations failed to produce an agreement.

The government, which had set a deadline of Friday for the banks to renegotiate the contracts, would “proceed to defend its interests by taking action in the competent courts,” she said.

Santander Totta is understood to have sold derivatives that the government believes could result in potential losses for the state of about €1.3bn. Contracts sold by JPMorgan are estimated to involve potential liabilities of about €300m.

Santander Totta said its contracts, designed to protect companies from interest rate increases, were “not of a speculative nature”. They had been agreed before the 2008 international financial crisis “in a context in which interest rates were expected to rise”.

It added that potential losses from the contracts incurred by state companies did not constitute “profits for the bank”. Santander Totta said it had made “very favourable” proposals in the negotiations with the government, which had not been accepted.

An agreement was reached with some lenders, which the government said would enable it to save about €600m in potential liabilities and €170m in interest rates over the next few years. The banks involved in this deal were identified in the Portuguese media as Nomura, Credit Suisse and Barclays.

Three other banks, reported in Portugal to be Goldman Sachs, BNP Paribas and Deutsche Bank, have asked for a few more days to attempt to reach an agreement with the government. The contracts sold by these three banks are understood to involve potential liabilities of about €800m.

Lisbon estimates that the potential liabilities from what is has identified as “toxic” hedging contracts sold to public sector companies between 2003 and 2010 could reach a total of €3bn.

Most were designed to protect companies from potential increases in the benchmark Euribor interest rate, a strategy that misfired after the rate fell sharply after September 2008.

Other hedging contracts were reportedly linked to fluctuations in oil prices and the euro-dollar exchange rate. Most of the potential losses pertain to the Lisbon and Porto Metro companies. Railway, bus and other state-owned companies are also involved.

“Typically, the contracts identified as problematic had positive effects in the short term, which temporarily improved financial results but at the cost of high future risks,” Ms Albuquerque said.

Some contracts had interest rates that were “well above 20 per cent, which even in a context of higher rates would not produce positive results” for the companies that bought them, she added.

Ms Albuquerque said the debt of non-financial state-owned companies more than doubled from €14.6bn at the end of 2004 to about €30bn in June 2011.

JPMorgan said: “We made a fair and reasonable proposal, which was rejected. We remain willing to continue the discussions.”