• The banking tower in Frankfurt, which hosts the offices of Alvarez and Marsal (Photo: Wolfgang Staudt)

Investigation

Troika consultancies: A multi-million euro business beyond scrutiny

16.12.13 @ 09:23

  1. By Valentina Pop
  2. Valentina email
  3. Valentina Twitter

Berlin - Alvarez and Marsal, BlackRock, Oliver Wyman, Pimco: The names mean nothing to the average European.

But the financial consultancies have played a central role in all the eurozone bailouts and have so far invoiced taxpayers in Cyprus, Greece, Ireland, Portugal and Spain over €80 million.

Their "independent" expertise is used by the "troika" of international lenders - the European Central Bank (ECB), the European Commission and the International Monetary Fund (IMF) - to decide how much countries or banks need to prevent a default.

They are often hired without a public tender, posing questions on transparency and accountability.

They are sometimes hired despite potential conflicts of interest, which arise from links to investment funds and other financial service providers.

The consultancies also hire subcontractors, posing extra questions on who has access to inside information and how they use it.

Aside from local law firms, the subcontractors almost always include one or more of the "Big Four" accountancy companies - Deloitte, Ernst&Young, KPMG and PriceWaterhouseCoopers (PwC).

The end result is a "golden circle" of a dozen or so large firms with a de facto monopoly on handling EU bailouts.

Take Alvarez and Marsal.

The New York-based consultancy earned €2 million for setting up and managing Spain's "bad bank" in 2012.

In a typical model, it brought in a Spanish law firm called Cuatrecasas, a Japanese financial services company called Nomura and PwC to help do the job.

It has also earned €6.6 million for its work on the Cypriot bailout.

But its work in Cyprus caused a scandal which brought the questions to light.

According to an internal audit by the Cyprus central bank board, it got the money despite being ineligible for part of the work.

The audit document - seen by EUobserver - shows it got €1.1 million plus VAT for evaluating Bank of Cyprus, the island's main lender, up to December 2012. It also got a service extension fee of €250,000 for continuing the work in 2013.

In December 2012, with Cyprus struggling to secure a bailout from fellow eurozone states, the central bank chief, Panicos Demetriades, shortlisted Alvarez and Marsal for several new contracts.

He did it despite the fact the board had "ruled out" the consultancy due to "potential perceived conflicts of interest" related to its Bank of Cyprus evaluation.

He then gave Alvarez and Marsal two of the new contracts despite the board's concerns.

In early 2013, it got €960,000 plus VAT and expenses of up to €270,000 for analysing the recapitalisation plans of Cypriot banks.

It also got €2.7 million plus VAT and expenses of up to €540,000 for helping to restructure Bank of Cyprus itself and Laiki bank.

The secret fee scandal

"Perceived conflicts of interest" was the tip of the iceberg, however.

The scandal erupted in October this year, when Cypriot media reported that Demetriades awarded Alvarez and Marsal another, whopping, fee of €15 million without the board's knowledge.

The bonus amounts to 0.1 percent of the total worth of the recapitalisation cost of Cypriot banks (€15.7 billion).

According to internal correspondence and draft contracts dating back to March 2013, the consultancy's executive director, Hal Hirsch, and Demetriades, in principle agreed to payment of the fee "by whatever means" the recapitalisation was to be carried out.

Following messy talks in Brussels, the final bailout agreement included the seizing of private savers' deposits over €100,000.

The secret bonus begs the question: How objective was Alvarez and Marsal's evaluation of Cypriot banks when it stood to get a cut of the bailout?

The scandal also shows what can happen when contracts are awarded behind closed doors.

Demetriades in a written note in October claimed he agreed to the fee under pressure from the US firm. The central bank audit document quotes him as saying the fee agreement was: "Signed under duress. Mr Hirsch threatened to move the entire Alvarez team out of Cyprus at the peak of the crisis if I did not sign."

In early September, after the central bank terminated its contract with the consultancy, it insisted that the whole amount - €15 million - should be paid.

But when the board rebelled, protesting that it had no knowledge of the deal, the US firm offered to take less.

"We will agree to a recapitalisation fee equal to €4.75 million. This is a very considerable and voluntary reduction and should not be subject to further negotiations," Hirsch wrote in a letter to the central bank on 19 September.

The scandal is not over yet.

The Cypriot parliament and the Cypriot public prosecutor have launched inquires into the events.

An Alvarez and Marsal spokesperson declined to comment because the inquiries are ongoing.

The firm is trying to squirm out of the situation.

It said in a letter to the central bank, dated 26 October 2013, that the board has "full discretion" in deciding the amount of its recapitalisation fee.

Meanwhile, the central bank board is casting doubt on Demetriades' claim that he agreed "under duress." It says he had six months to complain to the board or to the troika, but chose not to.

Alvarez and Marsal is not the only consultancy to get troika-related contracts without public tenders.

Getting sums wrong

In January 2011, the Irish central bank hired its competitor, BlackRock Solutions, shortly after the Irish government filed for an €85 billion EU-IMF bailout.

BlackRock Solutions is a small advisory unit within BlackRock, a US-based firm, which has, in recent years, become the world's largest asset management fund, overseeing €3 trillion of its clients' wealth.

It was hired to forecast how much Irish banks risk losing and to carry out a "stress test" on worst-case scenarios for the Irish banking system.

It got €30 million for the job.

It also shared the task with subcontractors, including another US-based firm, Boston Consulting Group, and Barclays Capital, a British investment bank.

The first hiccup came when BlackRock Solutions' got its bank profit forecast wrong.

The Irish central bank, based on the consultancy's figures, expected bank profits to amount to €1.9 billion between 2011-2013 even in the worst case scenario. But by June 2012, the banks only managed to make €0.4 billion.

Irish politicians had earlier admitted the selection procedure for BlackRock Solutions was not ideal.

Speaking in the Irish parliament in 2011, Irish finance minister Michael Noonan said he eschewed a public tender due to troika pressure.

"The central bank has informed me that in light of the requirement under the EU-IMF programme to use consultants under a very tight deadline for urgent financial stability purposes, it was not possible to apply normal tender processes," he noted.

During a TV show the same year, Irish central bank governor Patrick Honohan said the selection procedure was rushed.

"We have engaged some [consultancies] at high speed. It’s amazing when you pay large sums of money, how the best consultants in the world can come flocking," he told Irish broadcaster RTE on 1 March 2011.

Dodgy forecasts aside, some Irish MPs fear insider trading.

BlackRock Solutions had intimate knowledge of the situation inside Irish banks not just from its January 2011 contract.

The Irish central bank also hired the US firm to assist in the completion of the 2012 and 2013 reviews of the banks' capital needs.

At the same time, its parent firm, BlackRock, had, according to a company statement from April 2012, "client business in Ireland" worth "over €5 billion" and "assets domiciled in Ireland" worth €162 billion.

Pressed by MPs earlier this year to reveal the extent of BlackRock's acquisitions in Ireland since 2011, Noonan said the Irish central bank "does not have the information requested" and noted that, in any case, "they [Blackrock] observe EU and Irish procurement legislation/requirements."

Seven months later, BlackRock announced it will buy 3 percent of the Bank of Ireland - one of the banks which its subsidiary, BlackRock Solutions, "stress-tested" in 2011.

Tom McDonnell, an economist with the Dublin-based think tank Tasc, told this website there is no proof that BlackRock used insider knowledge.

But he said the set-up is "problematic" in terms of public perception.

"They are the biggest asset manager in the world, so it would give them a competitive advantage if they used that insider knowledge. This is not to say they have done it, but it creates a perception and the possibility or temptation to do it," he noted.

Making heads spin

Greece also gave BlackRock Solutions a similar contract worth €12.3 million.

It included subcontracting to the Big Four audit firms.

According to a New York Times report in 2012, the troika and anything linked to it had become so hated in Greece that BlackRock Solutions used a fake name ("Solar") and recruited 18 armed security guards to do its work.

In September 2012, Cyprus also hired Deloitte and Pimco, the world's largest bond investor and an asset management firm of a size to rival BlackRock, to look at bank recapitalisation.

It later hired BlackRock Solutions/Solar to double-check the methodology of Pimco, in a decision which might make McDonnell's head spin.

The Spanish government was more wary than its Irish and Greek counterparts.

BlackRock Solutions also pitched for a contract to stress test local banks as part of troika requirements for Spain's €41 billion bank bailout.

But Spanish economy minister Luis de Guindos said in May 2012 that BlackRock Solutions risked conflict of interest with BlackRock's investment activities.

BlackRock's business in Spain is estimated to be worth €5.1 billion.

The same club still got the Spanish taxpayers' money, however.

Spain awarded the €10.3 million contract to Oliver Wyman, another US consultancy, and Roland Berger, a German firm.

It also hired Deloitte (€1.8mn), Ernst&Young (€7.2mn), KPMG (€5mn), and PwC (€5.3mn), to carry out audits.

Portugal, like Spain, hired Oliver Wyman to assess the recapitalisation of the local banking system under its troika programme.

It got €1 million for 44 days of work.

PwC, the US bank Citi, and McKinsey, another US consultancy, did subcontracting.

In September 2013, the ECB followed suit: It hired Oliver Wyman to assess the balance sheets of the 130 largest banks in the eurozone.

It declined to give details about the fee or the tender procedures which led to its choice.

Why do they do it?

The question arises as to why these firms keep on being hired and what motivates them to seek troika-related work.

Neither BlackRock, Oliver Wyman, Pimco or any of the other consultancies and audit firms were available for comment.

But Constantin Gurdgiev, a finance lecturer at Trinity College Dublin, says lack of expertise in central banks is one reason.

He told EUobserver that "during the pre-crisis boom in credit creation, national central banks of countries with rapid credit expansion lost core personnel competencies and skills to staff migration to the private financial services providers."

He added that the remaining staff "often performed mechanical tasks of collating and repackaging" data submitted by banks, but "lost the key skills to actively investigate banks' balance sheets or draw up business performance models."

The troika's demand for data and for management of crisis reforms were more than central banks could supply.

Hiring big names in the consultancy business also lent governments in bailed-out countries more credibility, especially in financial markets.

The "external validation" of the US firms gave the banking loss estimates a "perceived objectivity" which markets could live with, Gurdgiev said.

Richard Boyd Barrett, a left-wing Irish MP who tabled several parliamentary questions on BlackRock Solutions, is more cynical.

He told this website the major consultancies and auditors are "part of the same golden circle of bankers and government officials that caused the financial crisis in the first place."

Another source said the consultancies' main motive is not multi-million euro fees, but "contact" with government people.

The source - a former Irish tax official, who asked to remain anonymous - recalled meetings with PwC representatives who "basically introduced [US internet firm] Facebook into Ireland."

The source said: "The bureaucracy, in the sense of senior civil servants, happily arranged meetings with PwC clients or even prospective clients … You would discuss with them the Irish tax system. It was all very friendly."

Big firms like BlackRock claim to have "Chinese walls" which separate their consultancy work from their other activities.

But people who know how the system works do not agree.

"I don't think it's possible at any stage to operate Chinese walls. People just talk. It's not feasible," the Irish source noted.

"If PwC four or five years ago had a particular query about taxation, it was able to consult the database and say: 'The person you need to contact within the Irish tax revenue service is so and so and he has specialised knowledge about that area'," the source added.

"The idea that they don't have those types of links is completely wrong. That's how they operate, that's how they make their living," the source said.

This story is part of a cross-border investigation on the troika of international lenders. It includes journalists from Belgium, Cyprus, Germany, Greece, Ireland, Portugal, and the UK. It was partly facilitated by the German Heinrich Boell Foundation