Hedge funds sue Stanchart over Castex derivative contracts

A group of hedge funds, including Arrowgrass, Highbridge and Pine River, has sued Standard Chartered Bank in a London court over who should hold the losses on derivative contracts tied to bonds of auto parts maker Castex Technologies, The Financial Times reported on Monday.

As per the funds, Castex Technologies manipulated its share price so it could force the conversion of its convertible bonds into equity. This was after Castex’s share price rose steeply before falling just as dramatically in March and July last year. The hedge funds say in court papers that the swings are “consistent only with manipulation” and are “suspicious”.  

Castex had issued $130 million in bonds in 2012, with Stanchart as the lead arranger. Standard Chartered then sold the hedge funds a type of call option called “asset-swapped convertible option transactions”, or Ascots. Pine River also owns some bonds directly.

But the suit by hedge funds in a London Court is curious as the Securities and Exchange Board of India (Sebi) that probed unusual movements in 2015 had said in November last year that it hadn't yet found any signs of wrongdoing.  “We have not found any instance of market manipulation or unfair trading practices so far,” Sebi Chairman UK Sinha had said in an interview to Bloomberg. “If we find any evidence, they will not be spared.” Sebi has not come out with any official statement on Castex enquiry as yet.

Castex promoter Amtek group owes over Rs 26,000 crore to 32 banks, including State Bank of India, ICICI Bank, Axis Bank, Bank of Baroda, Bank of India, IDBI Bank, Bank of Maharashtra and UCO Bank.  The group plans to sell assets to repay loans.

Some holders of Castex's convertible bonds complained to Sebi in September last year, alleging manipulation of its shares with an aim to inflate the price and trigger conditions for a mandatory conversion of debt.

Under the bonds’ terms, Castex was entitled to convert them into equity at a fixed price if its share price exceeded Rs 130, an amount more than twice its average trading level, after April 5, 2015 for 30 consecutive trading days.  During share price swings in mid-2015, the stock reached as high as Rs 344 in July. As on Monday, Castex shares were trading at close to Rs 14.

Standard Chartered has told the funds that they must pay more than $30 million to buy the shares issued in place of the bonds related to their options and to pay the bank the value of the bonds.

While the dispute itself is not as large as many that banks face, the allegation from leading hedge funds is an added problem for Standard Chartered as it grapples with the UK referendum fallout, the FT said.

The funds have asked the High Court in London to rule whether the Castex share price was manipulated, and therefore that the conversion should never have happened. If the court does decide that the conversion was valid, then the funds are seeking assurance from the court that they are not obliged to buy the Castex shares, but rather options over those shares.