Open questions in connection with the takeover of Credit Suisse by UBS
On the evening of 19 March 2023, the Federal Council, accompanied by representatives of the Swiss National Bank and the Swiss Financial Market Supervisory Authority (FINMA), as well as the respective chairmen of the boards of directors of UBS and Credit Suisse, announced the takeover of Credit Suisse by UBS in the form of a statutory merger of the two entities, with a merger ratio of 22.48 Credit Suisse shares to 1 UBS share.
The Federal Council has taken two important decisions under emergency law (Art. 184 para. 3 and Art. 185 para. 3 of the Swiss Constitution), which deviate from existing federal law. The first, which has been widely publicized, is the suppression of the rights of the shareholders of Credit Suisse and UBS to approve the merger. The second, which initially went unnoticed, is the full write-off of additional equity capital (AT1) of Credit Suisse in the amount of 16 billion Swiss francs.
These decisions, along with other measures to stabilize the markets, were published in the Official Compilation of Swiss Laws on 20 March 2023 in a so-called Ordinance on additional liquidity assistance loans and the provision of default risk guarantees by the Confederation for liquidity assistance loans from the Swiss National Bank to systemically important banks (hereinafter the CS-UBS Ordinance), and an explanatory report was published by the Federal Council.
Open questions in connection with the takeover of Credit Suisse by UBS
Write-off of Additional Equity Capital (AT1)
According to the Capital Adequacy Ordinance, the capital taken into account is composed of Tier 1 capital and Tier 2 capital. The core capital consists of the Common Equity Tier 1 (CET1) and the Additional Tier 1 (AT1). In the event of a hardship, losses are absorbed by the capital elements in accordance with the following principles: (i) losses are absorbed by Common Equity Tier 1 before encumbering Additional Tier 1; and (ii) losses are absorbed by Additional Tier 1 before being charged to Tier 2 capital.
According to the wording included in Credit Suisse AT1 instruments' prospectus, the conversion or write-off mechanisms for these instruments are triggered by the occurrence of a viability event. “Viability Event” are either: (i) the Regulator has notified CSG that it has determined that a write-down of the Notes, together with the conversion or write-down/off of holders’ claims in respect of any and all other Going Concern Capital Instruments, Tier 1 Instruments and Tier 2 Instruments that, pursuant to their terms or by operation of law, are capable of being converted into equity or written down/off at that time, is, because customary measures to improve CSG’s capital adequacy are at the time inadequate or unfeasible, an essential requirement to prevent CSG from becoming insolvent, bankrupt or unable to pay a material part of its debts as they fall due, or from ceasing to carry on its business; or (ii) customary measures to improve CSG’s capital adequacy being at the time inadequate or unfeasible, CSG has received an irrevocable commitment of extraordinary support from the Public Sector (beyond customary transactions and arrangements in the ordinary course) that has, or imminently will have, the effect of improving CSG’s capital adequacy and without which, in the determination of the Regulator, CSG would have become insolvent, bankrupt, unable to pay a material part of its debts as they fall due or unable to carry on its business. As such, the conditions for writing off Credit Suisse's AT1 instruments are met.
In Article 5a of its CS-UBS Ordinance, the Federal Council authorized FINMA to order Credit Suisse (both the bank and the holding company) to write down Additional Tier 1. FINMA announced that it had used this authorization and ordered the full write-off of CHF 16 billion of Credit Suisse's Additional Tier 1 (mainly contingent convertible or CoCo bonds).
In its explanatory report, the Federal Council states the following: "The approval of the commitment credit for the granting of a liquidity assistance loan with default risk guarantee is intended to prevent consequences for systemically important banks' capital endowment that could threaten their existence and thus to make a significant contribution to the continued operation of the borrower and the financial group. Therefore, the granting of a liquidity assistance loan with a default risk guarantee and the commitment credit required for this purpose constitute a decisive state support measure to avoid insolvency and thus the provision of state aid to the bank concerned. In this context, FINMA can order the amortization of additional core capital as soon as the commitment credit is approved. The order in question may be addressed to the borrower and the financial group. It is up to FINMA to define the recipients of this order. The amortization of additional core capital under Article 5a may also be ordered in view of a takeover or repurchase scenario without which the borrower would have been immediately insolvent."
In its explanatory report, the Federal Council therefore does not mention why it authorizes FINMA to deviate from the rules established in the Capital Adequacy Ordinance. Both the chosen solution and the lack of explanation on this subject raise many questions. In its press release, FINMA does not provide any further explanation ("The extraordinary government support will trigger a complete write-down of the nominal value of all AT1 shares of Credit Suisse in the amount of around CHF 16 billion, and thus an increase in core capital.")
Since the Federal Council relies on emergency law, its ordinance is immediately applicable (for information, this same constitutional basis was used to take restrictive measures during the Covid pandemic). Moreover, such an ordinance can only be challenged in a concrete case and not abstractly. For the enactment of the CS-UBS Ordinance, the Federal Council relies on two articles of the Swiss constitution, art. 184 (foreign relations) and art. 185 (external and internal security). What is important to note here is that the measures taken by the Federal Council in application of these articles must be limited in time. The CS-UBS Ordinance is thus limited to 6 months and Swiss parliament will therefore have to validate (or not) the measures within the above-mentioned period.
It is also interesting to note that Switzerland has signed over 120 Bilateral Investment Promotion and Protection Agreements (BITs). The purpose of BITs is to afford international law protection from non-commercial risks associated with investments made by Swiss nationals and Swiss-based companies in partner countries - and, inversely, investments made by the nationals and companies of partner countries in Switzerland. Such risks include state discrimination against foreign investors in favour of local ones, unlawful expropriation or unjustified restrictions on payments and capital flows. To these provisions have been added obligations on the part of the contracting countries to treat investments made by investors in the other signatory country ‘fairly and equitably‘. In addition, contracting countries are required to respect state commitments made to specific investors in relation to corresponding investments.
Thus, these aspects should also be analysed in order to know whether a foreign investor could claim against Switzerland in connection with the derogation measures provided for in the CS-UBS Ordinance.
Suppression of shareholders rights
Another measure of the CS-UBS Ordinance that has been widely commented on is the abolition of the participation rights of the shareholders of Credit Suisse and UBS who, contrary to current positive law (i.e. the Swiss Merger Act), will not have the power to approve or reject the statutory merger of the two legal entities.
In its CS-UBS Ordinance, the Federal Council has indeed excluded the shareholders' approval and also excluded the application of articles 11 (preparation of interim balance sheet), 14 (publication of a merger report), 15 (audit of the merger report) and 16 (shareholders' consultation rights) of the Swiss Merger Act, both measures to the extent the merger operations are concluded with FINMA approval. In addition, other transaction requirements set out in the Swiss Merger Act may be waived with the consent of FINMA if special circumstances so require; in such cases, FINMA will first consult the relevant cantonal commercial register authorities and the Federal Office of the Commercial Register.
The explanatory report of the Federal Council merely states that special circumstances exist, in particular, in the event of an emergency and the need for a rapid takeover in order to protect the Swiss economy and the Swiss financial system from considerable damage.
What is notable, however, is the lack of exclusion of article 105 of the Merger Act. According to this article, shareholders may file a claim for "appropriate" compensation within two months of the publication of the merger resolution in the Swiss Official Gazette of Commerce if they are disadvantaged in the merger. The judgment in such an action applies not only to the shareholder who has filed the action, but to all shareholders in a similar position, regardless of whether they have participated in the litigation.
As it stands, therefore, it cannot be ruled out that the merger ratio of 22.48 Credit Suisse shares for one UBS share may be challenged in court by Credit Suisse shareholders (as well as UBS shareholders).
We will in any case continue to monitor the situation and do not hesitate to contact us for additional information.