The Swiss financial regulator is being dragged into court for allegedly depriving holders of Credit Suisse AT1 bonds of their money during the forced takeover by UBS. A negative court ruling could cost Swiss taxpayers billions of francs.
This content was published on June 16, 2023
swissinfo.ch
On March 19, the Swiss Financial Market Supervisory Authority (Finma) caused a stir with the controversial cancellation of $17 billion (CHF 15.5 billion) of Credit Suisse’s so-called AT1 bonds.
>> What it takes to merge two Swiss banking giants
Around 2,500 bondholders, scattered from the United States to Japan, have since filed complaints with the Federal Administrative Court.
What are AT1 bonds?
Additional Tier 1 (AT1) bonds are financial bonds created after the 2008 bank crash to protect banks from collapsing if they got into trouble.
Regulators like Finma insist that big banks have to issue a certain amount of these debt instruments as a buffer against bankruptcy.
Investors accept that the bonds will be converted into bank shares in the event of extraordinary financial difficulties. In return, AT1 bonds pay higher coupons (interest payments) than regular bonds.
At the takeover by Credit Suisse, AT1 investors got nothing, while the bank’s shareholders were offered new shares, albeit at an extremely low price of CHF 0.76 per share.
The write-down of the bonds removed the usual primacy of the creditors of an insolvent company, who normally prefer the bondholders to the shareholders.
End of insertion
“Investors must accept risk”
The complainants want the court to declare the write-off of the bonds illegal and the debt instrument reinstated. Should the court grant this claim, UBS would inherit this $17 billion debt.
An indebted UBS would then become the aggrieved party, since Finma and the finance department promised it that the bonds would be written off as part of the takeover, says law professor Peter V. Kunz from the University of Bern.
“I’m sure UBS would protest because they trusted the authorities,” Kunz told SWI swissinfo.ch. “You could ask the federal government for a few billion back.”
According to Finma, it was always clear that the bonds would be written off in the so-called “viability case” – that is, if the bank would definitely go bankrupt without state aid.
Swiss Finance Minister Karin Keller-Sutter, who played a key role in the takeover, told Swiss television SRF that investors sometimes have to take losses. “This is ultimately capitalism,” she said. “Anyone who takes a risk must know that it can also go wrong.”
Who is complaining?
The Federal Administrative Court received 230 lawsuits relating to Credit Suisse AT1 bonds. Behind it are around 2500 investors.
Quinn Emanuel Urquhart & Sullivan represents around 1000 investors from Europe, the USA, Africa, the Middle East and Asia.
According to Thomas Werlen, Managing Partner of this law firm, the investments of private banks, cantonal banks, pension funds and “many” private individuals were destroyed.
The pension fund of Migros, the largest retail chain in Switzerland, is also one of them. She lost 100 million francs when the bonds were written off.
Some top managers at Credit Suisse are also said to have complained because some of their bonuses were affected by the write-off. However, they were later persuaded to withdraw their complaints.
The law firm Pallas Partners claims to represent 90 “global institutional investors and asset managers” whose bonds were written off by $1.35 billion, as well as “private clients and family offices” with claims totaling $160 million.
Law firms in Singapore and Japan are also preparing lawsuits against the Swiss authorities, possibly through arbitration under the international investment treaties these countries have signed with Switzerland.
End of insertion
Appropriate and proportionate?
However, law firm Quinn Emanuel Urquhart & Sullivan, which represents hundreds of clients who have bought around 5.5 billion francs worth of bonds, says the write-down is unjustified.
Although Credit Suisse was hit by an extraordinary bank run, it was otherwise a viable company with plenty of capital. This raises the question of whether a real “remediation case” in the sense of the legal definition ever occurred.
>> How the Swiss trio forced UBS to bail out Credit Suisse
“The question is: Was that a suitable measure to solve Credit Suisse’s problems? I dispute that,” Thomas Werlen, managing partner of the law firm, told the newspaper “Finanz und Wirtschaft”.
The lawsuit received a boost when documents emerged from Credit Suisse showing that the bank itself had challenged Finma’s decision to write off the debt.
How much would the compensation be?
Whether the write-down of the bonds, which was bolstered by the government’s emergency law, was an appropriate response to the Credit Suisse drama will have to be decided by the courts. This is a legal “grey area,” says Kunz.
Should the court refuse to restore the bonds, the plaintiffs will still seek compensation, as their assets have been “expropriated” by Finma, just as private land can be expropriated for public use.
The exact amount of the compensation is disputed given the volatility Credit Suisse AT1 bonds experienced in the run-up to the frenetic takeover weekend. The bonds traded at around 40 percent of their face value as of March 17, the last trading day before the acquisition — a market value of around $6.8 billion.
The courts could order Finma – and ultimately the taxpayers – to pay out this sum to the injured party. However, it is by no means clear whether the court would use this calculation as a benchmark for compensation.
In order to receive any compensation at all, the plaintiffs must convince the court that the Federal Council’s enactment of the emergency law, which made the takeover of Credit Suisse possible, was tantamount to expropriation. Such a judgment is also a matter of interpretation.
image damage
Even if the courts dismiss all of the plaintiffs’ claims, major Swiss banks could suffer collateral damage. AT1 bonds are an essential component for banks to meet capital requirements.
If the financial market loses confidence in Swiss bonds, the banks will have to pay higher interest rates to persuade investors to buy their debt securities.
“If this stays the same, how can you trust a debt instrument issued in Switzerland or Europe when governments can easily change the laws after the fact?” asked David Tepper, billionaire founder of investment firm Appaloosa Management, in the Financial Times.
Both the European Central Bank and the Bank of England rushed to say they would not cancel AT1 bonds as easily as Finma did in the event of a bank failure. This isolates Switzerland from other European countries.
“A ‘Swiss legal uncertainty premium’ would be an unfortunate outcome, as it would lead to a permanent competitive disadvantage for the systemically important Swiss banks compared to their foreign competitors,” says Andreas Ita, managing partner of the risk consulting firm “Orbit36”.
According to Ita, in order to avoid this problem, the conditions of future Swiss AT1 bonds would have to be changed so that investors can be offered more security. According to Ita, this would require a change in Swiss capital market regulation.
Translated from English: Christian Raaflaub
In accordance with JTI standards
More: JTI certification from SWI swissinfo.ch