Following weeks of turmoil within Credit Suisse, which saw a massive fall in share prices and investor confidence, UBS has agreed an emergency takeover of the Swiss banking giant. The Swiss regulator FINMA announced on Sunday (19 March 2023) that, as part the rescue deal, the bank’s Additional Tier-one bonds (“AT1 bonds”), also known as contingent convertible bonds or Co-Cos, will be written down to zero, while shareholders will receive USD 3.23bn.
Whilst the shareholders have also suffered significant losses, the decision to prioritise shareholders over bondholders is highly controversial. The AT1s were created following the 2008 Global Financial Crisis as a means to absorb losses and to avoid the need for the types of taxpayer bailouts, which were implemented to save various financial institutions. While deemed to be high risk investments, AT1 bondholders are ordinarily prioritised over shareholders when emergency measures come into play. However, FINMA’s decision at the beginning of this week reverses this capital hierarchy and means Credit Suisse shareholders are prioritised over bondholders, and as a consequence, the bondholders have lost $17bn.
The FINMA announcement sent immediate shockwaves across the global financial markets. The European Central Bank Supervision Authority, Single Resolution Board and the European Banking Authority were swift to issue a joint statement on Monday this week seeking to calm the markets and distance themselves from FINMA’s decision. They have given reassurances that Switzerland is outside the EU’s regulation and insist that the usual approach – that common equity instruments absorb losses before AT1s are written down – will continue to guide their actions and will apply to cases under their regulation.
The European joint statement is consistent with their approach in past cases, in particular their approach in the overnight rescue of Spanish bank, Banco Popular. Last year, the European Court of Justice ruled that the EU’s restructuring and resolution directive applied to the Spanish bail out and this meant shareholders in Banco Popular ranked below bondholders in the priority order.
What does this mean for AT1 bondholders?
There are reports that various Claimant law firms (including Quinn Emmanuel Urquhart & Sullivan and Pallas Partners) are currently in discussions with Credit Suisse AT1 bondholders, including various institutional and hedge funds, about the possibility of legal recourse to challenge the FIMNA decision and the terms of the rescue deal, potentially in Switzerland, London and New York.
The bonds were subject to a provision which enabled the Swiss authorities to write them down to zero should the bank become ‘non-viable’, regardless of whether the shares were also wiped out. Legal arguments are expected to turn on the contractual wording of this ‘write-down’ clause and whether FINMA’s interpretation of it was correct. Legal issues may include: was the clause sufficiently flexible to allow the AT1s to be written down to zero and prioritised ahead of shares? Was the clause triggered at all in circumstances where there were viability concerns, but the bank was not actually insolvent? If FINMA’s interpretation of the write-down clause was incorrect, did it nevertheless have the regulatory power to reverse the usual order of priority between bondholders and shareholders? Should the emergency deal have been pushed through so quickly without a vote?
Whilst investment funds are apparently considering legal action of their own, it is also possible that they themselves might ultimately become the target of claims for investing in AT1 bonds. Credit Suisse’s AT1 bonds offered high yields (almost 10% p.a.), reflecting the inherent risks in these investments, so fund managers will, no doubt, have factored this risk into their investment portfolio decision-making. But equally, they will not have expected the bonds to become worthless overnight and it is anticipated that fund values will be significantly impacted. Claims, if brought, may focus on whether fund managers invested too heavily in these ‘high risk’ bonds and whether they gave appropriate risk warnings to their clients before investing in their funds.
It is too early to say whether any litigation by the investors or against the fund managers would be meritorious (and indeed, there may well be significant causation, reliance and quantum hurdles to overcome), but if such actions are brought then the banks and fund managers are likely to look to their insurers for cover in connection with their involvement in such claims.
We will be closely monitoring developments in this matter. Should you have any queries, please do not hesitate to contact William Allison.
