Capital Markets

The Parmalat Archipelago

Abuse of ''special purpose entities'' was at the heart of the Italian food group's demise, but Parmalat is just another illustration that SPEs don'...
Tony McAuleyFebruary 9, 2004

It was a small irony buried deep in the morass that is the Parmalat scandal. While investigators across the globe were trying to fathom how billions of euros disappeared through an archipelago of hidden offshore “special purpose entities,” Standard & Poor’s quietly reaffirmed the AAA credit rating of one little Parmalat vehicle.

It was a missed debt payment by a Parmalat subsidiary in Brazil that triggered the €9 billion Italian food giant’s implosion in December. And it was in Brazil that S&P credit analyst Juan de Mollein reaffirmed the top rating of the Parmalat Fundo de Investimento em Direitos Creditórios (FIDC), on January 15th, explaining that the SPE “has sufficient receivables isolated from the originators to provide the appropriate level of credit enhancement.”

In the end, the FIDC’s shareholders decided to exercise their right to bail out early, despite the assurance from S&P, and voted on January 19th to distribute the money in the fund (about 112m Brazlian reais, or €33m) among themselves and leave the vehicle dormant. The sponsoring bank, Banco Itau BBA, put on a brave face. “Shareholders didn’t feel comfortable carrying on with the fund in the present situation,” says Fernando Iunes, director of capital markets at Banco Itau BBA in Sao Paulo. “But it did demonstrate that it is insulated from the credit risk of Parmalat itself. It proved to be safe.”

Swimming Upstream

The fact that the Parmalat FIDC did what it was supposed to, and all the investors (mainly Brazilian pension funds) got their money back, is, of course, a cry in the wilderness when set against the broader Parmalat debacle. But the Parmalat FIDC may provide a little ammunition to those trying to make the case for legitimate off-balance-sheet financing.

Brazil has been slowly accepting securitisation, though Parmalat was only the fifth FIDC since the end of 2001, when Brazil’s securities regulator passed rules to allow bankruptcy-remote entities for pooling assets. The banks are hoping to see the market boosted this year by a trade receivables FIDC issue from Companhia Paulista de Força & Luz, the local electricity giant.

But the fragile situation shows how abuse of SPEs has undermined public confidence, putting development of securitisation markets, one of the great capital markets phenomena of the last two decades, at risk. SPEs were fundamental to the growth of the mortgage- and asset-backed markets in the US in the early 1980s, which spread to Europe and beyond in the 1990s, and are now worth more than a trillion dollars world-wide. Securitisation hit its peak at the end of the 1990s, when companies like Enron argued that virtually everything could be securitised—from credit card debt and car loans to future receipts on David Bowie’s recordings and even the weather.

Enron’s collapse led to the speedy introduction of tighter rules governing SPEs, including the US Financial Accounting Standards Board’s Interpretation No. 46 in January 2003. The rule defined an off-balance-sheet firm according to economic interest rather than legal control. This threatened to make bank sponsors of securitisations consolidate the debt on their balance sheets, until concessions were made late last year. In the meantime, asset-backed securitisation issuance in the US plummeted $33 billion (€26.5 billion) in the first quarter and only began to recover at the end of the year.

Back at Parmalat, its annual report for 2002 recorded hundreds of consolidated subsidiaries, and reportedly it had hundreds more off-balance-sheet SPEs. One such Cayman Islands financial subsidiary, Bonlat Financing, looks to be the rotten core of the scandal. The company had said its entire liquidity position—€E4 billion in cash and marketable securities—was in that company, backing up the claim for auditors with an allegedly forged letter from Bank of America. More directly related to securitisation, investigators began in late January to look into whether the Tanzi family, who controlled Parmalat, sent false bills from dozens of Italian milk distributors to be securitised in two “conduit” securitisation vehicles run by Citibank, dubbed Eureka.

It will take months of deciphering. Meantime, accounting rule-setters are taking a look. In December, the International Accounting Standards Board reviewed IAS 27 on consolidation and SIC 12 on SPEs. But fine-tuning consolidation rules won’t be the answer, says Kevin Stevenson, IASB technical director. “If you tell companies they can’t do A or B or C or D, but don’t comment on E, they’ll do E.” A major IASB review of consolidation rules, due in 2005, hopes to deliver clear principles about balance sheet consolidation, Stevenson says.

In any case, Parmalat, like Enron and the other fraudsters, was not just skirting rules but seeking to mislead in a big way. “They claimed to be using international accounting standards, but they must have been spelling international with a small ‘i’,” says Stevenson.