The New Zealand Superannuation Fund has confirmed this morning that it has filed debt recovery proceedings in the English courts against the Portugese bank Novo Banco.

It added that Oak Finance investors "would also shortly be filing public law proceedings in Portugal against the Bank of Portugal, challenging the validity of the Bank's decision purporting to retransfer the Oak Finance loan, with retroactive effect, from Novo Banco to Banco Espirito Santo."

Its litigation against the Portuguese central bank, the Bank of Portugal, could end up before the European Court of Justice, said the fund's chief executive, Adrian Orr.

After appearing before Parliament's commerce select committee yesterday he said the European Parliament had introduced bank resolution law in the middle of last year, one of whose key provisions was that all senior debt holders should be treated equally in the event of a bank failure.

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"And we clearly haven't been."

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Even after writing off its US$150 million ($198.2 million) loan to Banco Espirito Santo the fund yesterday reported earnings of $4.4 billion in the past 12 months, a return of 17.5 per cent before tax and after costs.

It says the write-off is conservative and precautionary, and arises from events unforeseeable at the time the investment was made.

One was a retrospective and, the fund argues, unlawful change by the Bank of Portugal to the regulatory regime governing bank failures and related parties.

Another was its failure to distinguish between Goldman Sachs which arranged the loan syndicate (a special-purpose vehicle called Oak Finance) on the one hand and the investors including the Super Fund who lent the money on the other.

The effect was to carve out Oak Finance from other senior debt holders whose claims had been transferred to the "good bank", Novo Banco and, crucially, to nullify the insurance the fund had taken out (by way of a credit default swap whose counterparty is Goldman Sachs) which was supposed to protect it against failure of Banco Espirito Santo.

Such loan structures were commonplace, Orr said, hence the international interest in this case.

If a retrospective law change which allowed some senior debt holders to be treated differently from others and which failed to distinguish between a loan's arrangers and those providing the money was upheld it would be a disastrous precedent.

Earlier Gavin Walker, chairman of the Guardians of the Fund, told the select committee an internal review, conducted by fund staff independent of those who had made the decision to invest, had reassured the board that none involved had exceeded their authority and that the decision to invest had been consistent with the board's investment policies.

Questioned by MPs about the prudence of the loan Orr said that at the time the investment was made Banco Espirito Santo was reported to have 10.4 per cent tier one capital.

"That is, a very well-capitalised bank," he said.

And the day before the loan was drawn down the central bank had said Banco Espirito Santo had a solid solvency position.

But three weeks later its executive chairman, Ricardo Salgado, was detained for questioning on suspicion of fraud, money laundering and embezzlement.

"The key thing to get across here is that the credit risk we faced was against our insurer, not the bank," Orr said.

The lessons to be learned from the affair were subtle. Banco Espirito Santo was in some sense a national champion, a high-profile retail bank, and that might have heightened the regulatory risk, Orr said.

And the outcome might have been different if the Bank of Portugal had been able to see through the lender of record, Oak Finance, to the investors, including New Zealand's sovereign wealth fund, putting up the money.

Read a press release from Oak Finance here: