Derivatives scandal hits Riga

RIGA - Germany’s Deutsche Bank helped the Riga City Council in 2005 finance the construction of Southern (Dienvidu) Bridge with financial derivatives that sought to delay debt payments, and the money was spent without the local government reporting it as debt, reports the British magazine Risk. The Latvian government told the Riga City Council in 2005 that it could not borrow the entire amount of money necessary to build the Southern Bridge.

The solution proposed by Deutsche Bank - enhanced vendor financing (EVF) - was that the bank would provide the money to the construction company, Dienvidu tilts, in a series of payments, allow the city a five-year grace period before repayments start this year, and not need to be reported as debt. The downside to the deal was the expense incurred: 46 percent of the total 567 million lats’ (810 million euro) bill for the bridge was interest, Risk claims.

Separately, the construction company had an agreement with Riga City Council calling for the city to provide the money for those repayments. But the city council also sold Deutsche Bank credit protection on Dienvidu tilts, ensuring that if the company defaulted for any reason, the city will be on the hook for the full sum.
It was through this credit default swap that Deutsche Bank’s credit exposure was ultimately linked to Riga, rather than to the construction company. Once this was clarified by Eurostat, Eurostat then ordered Latvia to retroactively correct its figures for the budget deficit and debt levels for 2005 and 2006.

One senior European Union civil servant said the bank told Riga what it wanted to hear about the accounting treatment: essentially, that it could borrow money while calling it something else.
Early in 2007, Latvia’s authorities started to question Deutsche Bank’s accounting guidance, organizing a meeting at which the bank was asked to explain the financing scheme and its accounting. Afterwards, Latvia’s Central Statistical Bureau asked European authorities for advice and their decision was unequivocal: according to the September 2007 ruling, which forced Latvia’s debt and deficit restatement, EVF should “be considered a device whereby Deutsche Bank extends a loan to the City of Riga.”

The Latvian Audit Office audit came to the same conclusion, calling the scheme a series of “simulative transactions that conceal [Riga’s] borrowing.”

“The financing was fully transparent in the city’s accounts at all times,” Deutsche Bank spokesman Armin Niedermeier said. “And Latvia complied 100 percent with Eurostat’s clarified guidance, once issued.” However, Deutsche Bank stopped offering EVF to clients after the Eurostat ruling on Riga.