Anglo's €7.2b trade had 'no commercial substance', court hears
A CIRCULAR €7.2bn cash trade between Anglo Irish Bank and Irish Life and Permanent during the 2008 financial crisis had “no commercial substance,” an accountancy expert has told a jury.
The witness in the trial of Anglo’s former CEO David Drumm said the deal started off with €1bn, which could have passed back and forth “ad infinitum” as the transaction had no financial constraints.
Dan Taylor was giving expert evidence for the prosecution on the 66th day of Mr Drumm’s trial at Dublin Circuit Criminal Court today.
Mr Drumm (51) is pleading not guilty to conspiring to defraud by dishonestly creating the impression that Anglo's customer deposits were €7.2bn larger than they were in September 2008.
He is alleged to have conspired with Anglo’s former Finance Director Willie McAteer and head of Capital Markets John Bowe, as well as ILP’s then-CEO, Denis Casey, and others.
The case centres on a series of interbank deposits which circulated between Anglo and ILP.
The transfers were routed through Irish Life Assurance (ILA), returning to Anglo where they were then treated as customer deposits, which are a better indicator of a bank’s health.
Mr Drumm also denies false accounting, by providing misleading information to the market.
Mr Taylor, a partner at global accountancy firm BDO, told Paul O’Higgins SC, prosecuting, that he was asked to look at the 2008 transactions between Anglo and ILP.
He considered the year end planning process and series of funding initiatives “designed to improve the customer accounts figure on Anglo’s year end balance sheet,” as well issues related to the “commercial substance” of the ILP transactions.
He also considered the accounting rules and regulations that governed the way in which those transactions were viewed.
Mr Taylor said in fairly presenting a transaction or balance, its “commercial substance” had to be understood.
“Commercial substance is whether or not there is any underlying economic benefit or cost or business purpose,” he said.
There were three main relevant factors - the first was whether or not as a result of a transaction happening there was a change in the amount of cash flow either going out or coming in at a future date.
The second was timing - whether a transaction led to a change in the the timing profile of receiving or paying out cash in the future. The third factor Mr Taylor said he would look at in assessing commercial substance was the risk profile - whether a transaction resulted in for example a less risky asset being swapped for a more risky one.
Applying his analysis to the September ILP transaction, it resulted in a principal amount of €7.2bn being paid over and received back. There was a corresponding amount of interest paid of approximately €2.96m paid on the liability side of the transaction, with “exactly the same amount that was received in interest on the assets side.”
Therefore, as the total €7.2bn paid was equal to the amount received and the interest rate was the same they “effectively they cancelled each other out.”
On the “amount test”, he said he would regard the transactions as not resulting in any change as the bank was in “exactly the same position in its asset/ liability profile and interest and cost profile, as if it had never actually transacted at all.”
The “risk test” was looking at whether or not the asset profile changed.
“Because they were not subject to any security… I would regard the risk profile as not changing,” he said.
Mr Taylor contrasted this with a “repo” transaction, which is an agreement to sell and repurchase securities. Because repos were subject to the movement of an underlying asset, they involved an exposure to market risk, Mr Taylor said.
The jury has already heard Anglo entered into a separate “repo” transaction with ILP in June 2008.
The only risk that existed in the September ILP transaction was a settlement risk - in the event that the banking system collapsed and the transactions did not go through, Mr Taylor continued.
This risk did not create commercial substance, he said
Mr Taylor said there were no financial constraints to the transactions. He explained that an institution’s ability to enter a transaction would normally be constrained by its existing asset base or its ability to get funding.
“In this particular instance, the transactions were not bound by any financial constraints in that you have the initial amount, €1bn, to start the transaction on and the money is being passed back and forth,” he said.
“These transactions were only limited by how quickly, how many times the transaction could go back and forth… they could have continued ad infinitum. The only limit was the time that was available to put them through the payment system.”
Mr Taylor told the jury the term “balance sheet management” meant to present a balance sheet in its most favourable position within the bounds of an institution’s funding and ability to transact within its asset base.
In a repo or other balance sheet management, there would normally be a cost, he said. For example to increase customer deposit figures, interest rates could be raised.
“The difference between other forms of balance sheet management and these particular transactions is there doesn’t appear to have been a cost associated with it,” Mr Taylor said.
Mr O’Higgins asked Mr Taylor if the transactions had any effect on the liquidity of either institution.
“They did have an impact on liquidity because they showed that the sources of funding of the bank were from what was regarded as a more stable form of funding,” Mr Taylor replied.
Asked if there was an impact on the state of the bank, he said “there obviously wasn’t any income or cost associated with it but it demonstrated that important metric, that the customer accounts balance improved.”
“They were effectively transactions with an objective to increase a particular balance within the financial statement of the bank but when you look at the substance of the transactions as a whole, there was no commercial substance,” Mr Taylor said. “The asset profile of the bank didn’t really change at all,” he said.
The jury was told Irish banks prepared their financial statements in accordance with International Financial Reporting Standards and one of the standards that applied in the case was the IAS32.
Mr Taylor gave evidence through the afternoon on the role of accounting standards and frameworks in financial reporting.
His evidence in the trial is due to continue tomorrow.