The rescue deal agreed by UBS for Credit Suisse comes with plenty of financial pain for those invested in Credit Suisse but with a particular sting in the tail for holders of its additional tier 1 (AT1) bonds.
AT1 bonds are a creation born largely out of the last financial crisis. These contingent convertible (coco) bonds are designed to either be converted into equity or wiped out if certain events occur (such as a bank’s capital ratio falling below a set threshold). They bolster a bank’s capital position but with the aim ultimately of avoiding the need for taxpayer intervention.
Plenty of market participants appear to have seen AT1 bonds as having priority over the equity in a bank’s capital structure. Put simply, in the event of a crisis, the equity would be wiped out first, followed by the AT1 bondholders.
That view has been shown to be incorrect by the events of the last 24 hours. Based on current reports, it appears the equity holders will be paid out in full, albeit at a price reflecting the market economics of the rescue deal, but the AT1 holders will be wiped out.
The market is reacting accordingly with significant falls in the price of banks’ AT1 debt this morning. This seems to represent an effort to price in the perceived increased risk of loss in these instruments.
Some commentators have suggested that wiping out the AT1 holders is an unjustified frolic by the Swiss regulator. It seems unlikely the Swiss regulator is going against the wording of Credit Suisse’s AT1 bonds. It is much more likely the relevant parties have taken legal advice and consider they are able to wipe out the AT1 holders before the equity, or at least a good arguable case to do so exists. Given the stakes, they may have considered that the risk of future litigation is better than the alternative, although there is some precedent in the 2017 takeover of Banco Popular by Santander organised by the ECB oversight unit when its AT1s were wiped out.
We certainly saw many instances of the latter behaviour when litigating matters arising from the last financial crisis.
Given the sums at stake, holders of Credit Suisse AT1 bonds are likely to want to seek legal advice on whether the actions taken are allowed under the wording of the bonds and whether the actions taken by the Swiss regulator violate any protection afforded to that investor by a bilateral investment treaty or a similar instrument. These parties may also wish to consider whether they have been sold Credit Suisse AT1 bonds on a false premise or without being warned of the risks. As such, they may be questioning whether claims exist against third-party advisors for their loss.
As ever, the devil will be in the detail but it seems likely the courts will be involved in adjudicating issues arising from this transaction at some stage.
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