The following post is by a hedge fund manager friend of DB who shall remain nameless. He runs the emerging markets desk at his firm.
Emerging Markets and derivatives are like alcohol and barbiturates: each on its own has attractions but create a recipe for choking on one’s own vomit when combined. And despite all warnings, rock stars (or in the case of finance “rock stars”), real and aspiring, continue to do just that. The latest set of investors to get the Jimi Hendrix experience: writers of CDS on the Kazakh financial institution BTA Bank. The bank, by some measures Kazakhstan’s largest, declared its intent to restructure its debt back in late April, after the authorities alleged its loan book to be riddled with undisclosed related-party deals and its controlling shareholder, Mr. Mukhtar Ablyazov, fled the country. On a loan book of KZT 2.4 trillion, it has now provisioned nearly KZT 1.5 trillion, the sort of write-down that makes Merrill Lynch look like a bunch of pikers. Sadly for creditors, it didn’t occur to Mr. Ablyazov to try to pitch the bank to Ken Lewis.
The chicanery at BTA Bank itself is another story, though. ISDA’s Determinations Committee declared a credit event on April 29th. The baleful interaction of EM and derivatives relates to the CDS credit event auction. BTA Bank had issued a fairly full curve of eurobonds, most of which traded in the wake of the default in the mid-20s. The spirit of creativity was strong with the Kazakhs, though, and the bank was understood to have done a fair number of private deals. Less well-understood was the magnitude of off-balance sheet borrowing. A few “shell” borrowers – reputedly related to BTAS’s controlling shareholder — had taken out loans from western banks, which in turn got guarantees on these loans from BTA. The “shell” borrowers in turn onlent to Ablyazov-related entities (as Borat would say, “Naughty, naughty!”). Credit Suisse was the most active lender; at the time of making the loans – which yielded a premium to other BTAS obligations – it had gone and hedged itself by buying CDS from the market.

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