Hedge fund raises $200m for regulatory capital arbitrage vehicle

by chrisbrooks75

Hedge fund Chenavari Capital has raised more than $200m for a new listed vehicle to help European banks reduce their regulatory capital requirements by transferring risks off their balance sheets.

The Chenavari Capital Solutions fund, which will be floated in London, will allow banks to apportion losses against pools of problem or complex assets – including UK mortgages and German corporate loans – to Chenavari in return for sizeable premiums.  

Interest in such regulatory capital relief transactions – which critics say are in danger of recreating the kind of opaque, off balance sheet risks that caused the 2008 financial crisis – has been growing strongly. Chenavari is expected to unveil details of the flotation, advised by Dexion Capital, on Wednesday.

“We have been doing a lot of transactions in the last 18 months,” Loic Fery, Chenavari’s chief executive told the Financial Times. “There has been huge balance sheet inflation for European banks – the deleveraging requirements are particularly large.”

Chenavari already has about $1bn engaged in regulatory capital relief strategies open to private investors.

“If we want to be able to capture the opportunity set fully we need to raise more capital and the only way to do that is to diversify our investor base,” Mr Fery said.

Chenavari’s existing European Regulatory Capital fund, launched in 2011, made a 37 per cent return last year, beating the average hedge fund return of just 6.3 per cent.

Mr Fery said capital relief transactions benefit all concerned.

“Every single transaction we do where there is a layering of risk or a risk transfer, the bank will have to seek a priori approval for that from the regulator,” he said. “Is it better that risk stays in a 20 times levered, systemically important institution or is it better that the risk sits in a non-levered fund or investment vehicle?”

In a typical transaction, Chenavari enters into a derivative arrangement with a bank exposing the fund to a second-loss tranche of credit risk: the bank remains on the hook to absorb the first 5 per cent of losses, for example, but Chenavari agrees to absorb the next 10 per cent.

With such an arrangement a bank can cut the amount of capital regulators require it to have set aside in reserve and deploy it elsewhere, such as in new lending activities.

Chenavari’s new listed vehicle will target an annual return of 12 per cent, to be distributed to investors through share dividends.

Other prominent investors that have sought to take advantage of capital relief trades include Christofferson Robb & Co – which aimed to raise $800m for a new fund in 2010, even attracting a $100m investment from the World Bank – hedge fund Cheyne Capital and Axa Investment Managers.