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Scheme 'grotesquely complicated'

THE company that bought $49 million worth of a "grotesquely complicated" structured finance product for onsale to local councils in 2006 was struggling financially and losing market share to its competitors at the time, the Federal Court heard yesterday.

THE company that bought $49 million worth of a "grotesquely complicated" structured finance product for onsale to local councils in 2006 was struggling financially and losing market share to its competitors at the time, the Federal Court heard yesterday.

Local Government Financial Services Pty Ltd needed an injection of $15 million to retain a credit rating from Standard & Poor's, its former head Warwick Hilder told the court.

The injection was provided by the NSW Local Government superannuation scheme, which bought LGFS in 2004.

Mr Hilder, now retired and a former general manager, financial markets, at NSW Treasury Corporation, was one of just four employees of LGFS. Its key business activity in 2006 was "providing investment management services and facilities for local government entities in NSW," he said.

Many of the 183 local councils in NSW were buying structured finance products called collateralised debt obligations, or CDOs, from rivals including Grange Securities (bought by the US investment bank Lehman Brothers in 2007).

"Everyone was looking at new things to do with these products because Grange had made so much money out of them," Mr Hilder said.

He agreed with Simon Couper, QC, for LGFS's insurer Chartis Australia, that interest on the $15 million capital injection exceeded all other income in 2005.

"The decision was then taken that the salvation for LGFS was to become a product-seller?" Mr Couper asked.

Mr Hilder disagreed with the word salvation but said: "That's one way of looking at it."

"What you were looking for was a product which would compete successfully with CDOs?" Mr Couper asked.

Yes, Mr Hilder replied.

In 2006 LGFS decided on a product called a constant proportion debt obligation, or CPDO, which Mr Hilder said had similarities with and differences to a CDO.

In a paper for the LGFS board, he described it as "grotesquely complicated". He said yesterday: "I was having a bad day when I wrote that."

The CPDO, sold by the investment bank ABN AMRO, now part of Royal Bank of Scotland, was very complicated in its mechanics but simple in principle, he said.

Thirteen councils that lost 93 per cent of the $16 million they invested in the CPDO are suing LGFS, ABN and the credit rating agency that assigned it a AAA rating, Standard & Poor's.

LGFS, which retained some of the investment itself on which it lost $16 million, is also suing the bank and the rating agency.


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