Finance History | UBS, Bahnhofstrasse 45, Zürich, 2 October 1998 — The Bank That Hedged an Option on the Fund With Shares in the Fund

No institution lost more on Long-Term Capital Management than the bank behind this door. On 2 October 1998 its chairman and three other senior executives left. The relationship began with a refusal. When the fund came to Union Bank of Switzerland for credit in 1994, the bank's own credit group recommended turning it down, because LTCM had almost no track record and was already borrowing heavily elsewhere. Executives pressed, and the financing was approved anyway. By 1997 the bank wanted more than a lending relationship, and what it bought instead was a piece of arithmetic. In three tranches that June, August and October, it sold LTCM a seven-year call option on around a million of the fund's own shares, worth roughly $800 million, for a premium of $300 million that it agreed to put straight back into the fund. To cover the option it had just written, the bank bought those same LTCM shares. That is the part worth stopping on. A hedge is meant to be the thing that rises when the exposure falls, and here the hedge and the exposure were the same asset, so there was no leg of the trade that could pay when the fund went down. Nor could the position be unwound. Shares in a hedge fund have no market, LTCM reported to its shareholders once a month, and the contract obliged the bank to convert any shares it sold into a long-dated loan rather than simply selling them. The appeal had been that the structure turned what would otherwise be interest income into a capital gain, with a share of the upside attached. When the fund collapsed the write-off came to about 950 million Swiss francs, roughly $690 million at the time. Chairman Mathis Cabiallavetta went on 2 October, and three colleagues went with him. All of this landed on an institution three months old. UBS AG was formed on 29 June 1998 from Union Bank of Switzerland and Swiss Bank Corporation, a merger announced on 8 December 1997. The LTCM option was therefore struck by Union Bank of Switzerland alone, before the merger was even public, and inherited by a bank still working out who reported to whom. Bahnhofstrasse 45 has been the Zurich head office since the 1940s and remains one of UBS AG's two registered offices, the other being Aeschenvorstadt 1 in Basel. One detail is visible in the photograph. The three keys beside the entrance were Swiss Bank Corporation's mark, taken up by the merged bank, so the door of the Zurich house now carries the emblem of the Basel one. This is a working bank on a shopping street. The carved arch and its Mercury are the reason to stop, and they are free to look at. Photo: Fred Romero, CC BY 2.0, via Wikimedia Commons.