The Swiss regulator's decision to impose a 100% haircut on Credit Suisse’s AT1 bonds, in the context of the recent shotgun merger of UBS and Credit Suisse, understandably sent jitters around the AT1 market. Our Financial Services team examine the background and the outcome for the Credit Suisse AT1 bonds and whether this could be replicated in the EU. In addition, the team make some suggestions for issuing banks and investors to consider.
UBS and Credit Suisse’s shotgun marriage, brokered by the Swiss regulators on 19 March 2023, had been predicted but one of its terms shocked global financial markets. This was the Swiss authorities’ decision to order the complete write-down of Credit Suisse’s “Additional Tier 1” bonds (AT1 bonds), also known as "Coco bonds”, while at the same time facilitating a deal where Credit Suisse shareholders will receive 40% of their shares’ pre-merger market price. Traders and regulators globally scratched their heads. Wasn’t it supposed to be a key feature of the post-crisis regulatory reform agenda that equity would be wiped out first in a bank rescue?
Typical hierarchy preserved?
AT1 bonds are of course designed to absorb losses by being converted into equity, or being written down, if certain trigger events occur. But it has always been understood that typical creditor hierarchies would be applied by regulators in these circumstances, such that the bank’s common equity would sustain the first losses followed by bonds in their ranking order.
This has been such an article of regulatory faith that the Financial Stability Board (the G20’s financial standard-setter), in its Key Attributes of Effective Resolution Regimes (2014) states that “equity should absorb losses first” and that “creditors should have a right to compensation where they do not receive at a minimum what they would have received in a liquidation of the firm under the applicable insolvency regime (“no creditor worse off than in liquidation” safeguard).” This is why the ECB and Bank of England promptly announced that in any UK or European bank rescue, they would not follow the Swiss authorities’ approach.
The Swiss, unsurprisingly, are defending the position that they took. The Swiss financial regulator, FINMA, has released a statement confirming that, in its view, the contractual terms of the Credit Suisse AT1 bonds, which were governed by Swiss law, permitted their complete write-down, irrespective of what happened to equityholders. FINMA points to the concept of a “Viability Event” which, per the publicly-available prospectuses of certain AT1 bonds, states that the AT1 bonds may be fully written down if Credit Suisse:
“has received an irrevocable commitment of extraordinary support from the [federal or central government or central bank] (beyond customary transactions and arrangements in the ordinary course) that has, or imminently will have, the effect of improving [Credit Suisse’s] capital adequacy and without which, in the determination of [FINMA], [Credit Suisse] would have become insolvent …”
FINMA’s position is that this trigger was met by the extraordinary liquidity assistance loans granted to Credit Suisse by the Swiss National Bank shortly before the merger. A review of the prospectus discloses another power that could have been used by FINMA in these circumstances. Where FINMA opens restructuring proceedings, AT1 bonds can be cancelled, and the prospectus also states that if this happens:
“[FINMA] may not be required to follow any order of priority, which means, among other things, that the [AT1 bonds] could be cancelled in whole or in part prior to the cancellation of any or all of [Credit Suisse’s] equity capital”.
Despite the protestations of the ECB and Bank of England that nothing like this could happen in a UK or European bank rescue, what does the law say? The terms of AT1 bonds will need to be carefully reviewed by investors to identify whether they could be similarly at risk of subordination to equity. In very general terms, consistently with the European Banking Authority (EBA) template term sheet for AT1 bonds, many AT1 issuances of EU banks provide for write-down where a “Trigger Event” occurs. A “Trigger Event” is where the bank’s capital ratio falls below a prescribed level, and many prospectuses carefully disclose that “upon the occurrence of a Trigger Event, there may be a Write-down of the Notes even if other capital instruments of the Issuer are not written down or converted into CET1 instruments.” As a result, at least on a superficial initial review, there seems to be no legal guarantee that an EU bank’s AT1 bond could never be written down unless equity shareholders had first been wiped out.
Unsurprisingly, the c. $260 billion AT1 bonds market is now jittery. Investors are likely to shun new issuances, raising bank funding costs. There are already reports of potential legal challenges from disgruntled investors in the Credit Suisse AT1 bonds.
Our advice to banks considering AT1 issuances, or investors in such issuances, is to ensure that you first fully analyse and understand the legal write-down powers of relevant regulators and the legal recourse available if regulators act unpredictably.
The content of this article is provided for information purposes only and does not constitute legal or other advice.