Introduction
On 19 March 2023, the Swiss Financial Market Supervisory Authority FINMA (FINMA) issued an order instructing Credit Suisse Group AG (Credit Suisse) to write off the nominal value of its Additional Tier 1 bonds (AT1), which had a combined nominal value of around CHF16 billion, and to inform the bondholders concerned. The write-down was part of a wider package to rescue Credit Suisse, which included CHF250 billion liquidity support from the Swiss National Bank (SNB), a government guarantee to cover losses arising from a bespoke portfolio of Credit Suisse assets and the merger with UBS Group AG (UBS).
While the overall transaction was welcomed, the decision to write down the AT1 instruments sent shockwaves through the financial sector worldwide and led to a surge of appeals against FINMA’s ruling. A press release by the Federal Administrative Court, dated 15 May 2023, revealed that approximately 230 appeals, involving roughly 2,500 complainants, had been lodged against FINMA’s order. By August, the number of appeals had climbed to 320, with approximately 3,000 complainants involved. Although the Federal Administrative Court did not issue a statement as to when a judgment will be handed down, it is expected that these proceedings may run for quite some time.
AT1 bonds briefly explained
Following the 2008 financial crisis, the regulatory basis was established for capital instruments in the Additional Tier 1 (AT1) segment. The purpose of AT1 bonds was to provide banks with an alternative to Common Equity Tier 1 (CET1) capital that counts towards the Basel minimum Tier 1 requirement but in the form of a debt instrument. The newly devised instruments should, in a crisis, enable the company or the authorities to quickly create CET1 capital and thereby improve the balance sheet of the bank through the write-down or conversion of AT1 bonds into equity. In the event of extraordinary state assistance or to head off insolvency, AT1 bonds should be written off to prevent taxpayers from shouldering the risk (as occurred in 2008). Accordingly, the Basel definition designed AT1 instruments to be loss absorbing in going concern. This can result in AT1 creditors (different to bail-in bonds) having to bear losses before and independently of the initiation of formal restructuring proceedings. To balance this risk, AT1 bonds typically yield high returns. Surprising to many, it seems that AT1 instruments may be written down at a time when the shares still receive some value.
Key arguments – FINMA's perspective
FINMA contends that the prospectus forms the contractual basis for the write-off. The relevant clause provides that AT1 bonds will be completely written off in a “Viability Event”, in particular if extraordinary government support is granted. As Credit Suisse was granted extraordinary liquidity assistance by the SNB, secured only by a federal default guarantee on 19 March 2023 (and not against collateral as the Swiss National Bank Act requires), in addition to various other liquidity assistance in the preceding days, according to FINMA, the requirements for a viability event were met and the contractual conditions for a complete write-off of the AT1 bonds were given.
Based on the emergency law of the Federal Constitution of the Swiss Confederation (the “Constitution”), the Federal Council enacted, on 19 March 2023, the “Emergency Ordinance” which authorises FINMA to instruct the borrower and the financial group to write off AT1 capital. Based on the prospectus for the bonds and the Federal Council’s Emergency Ordinance, FINMA instructed Credit Suisse to write off all AT1 bonds.
Supporters of FINMA’s decision point out that the risks of the AT1 bonds were stated clearly in the prospectus and that the investors concerned knew or should have known of the possibility they might lose their investment. Some argue that this was the sole purpose of this instrument. The prospectus did not require equity to be written down ahead of the write-down of AT1. A transfer of value from AT1 to equity investors is inherent in any write-down instrument, once the contractual conditions of a write-down are met, and, depending on the exchange ratio, this could also happen with convertibles. This risk was balanced by high returns. The supporters further argue that sparing the AT1 bondholders would have been inappropriate, as this would have shifted the risks onto taxpayers instead. Supporters also argue that AT1 instruments would have been written off in any of the discussed alternative scenarios (liquidation of Credit Suisse, nationalisation or resolution followed by the conversion of bail-in debt into new shares). For these reasons, they consider FINMA’s decision to write off the AT1 to be correct.
Key arguments of the complainants
The complainants dispute the existence of a viability event. They contend that, based on the wording of the “Viability Event Clause”, such an event would have required Credit Suisse to have poor capitalisation. According to a joint statement dated 15 March 2023, by the SNB and FINMA itself (and repeated on 19 March 2023), however, this was not the case at the time emergency liquidity assistance was granted. Moreover, they argue that extraordinary government support impacted solely Credit Suisse’s liquidity, without affecting its capital structure, leaving aside that the SNB support maintained Credit Suisse as going concern. Adding weight to their argument, complainants highlight that Credit Suisse sought to buy back some of the AT1 just two days prior to the write-off (but FINMA denied the request), apparently showing that Credit Suisse itself did not perceive the situation as a viability event. This argument may not be particularly strong as the Credit Suisse Chairman, on Sunday evening, contended that Credit Suisse would not have opened the next morning without the rescue.
The claimants further argue that both the FINMA order and the Emergency Ordinance are unconstitutional. They justify this by pointing out that FINMA’s directive instructing Credit Suisse to write off AT1 constitutes an infringement on the constitutionally protected guarantee of ownership. According to the principles of proportionality outlined in the Constitution, any infringement upon a constitutional right must be both suitable and necessary (meaning no milder alternative was available) to achieve the public interest objective. Many complainants assert that alternative measures could have been employed, rendering the complete write-off unnecessary and therefore unconstitutional. This argument stands in contrast to public statements made by the authorities.
Finally, the complainants argue that the write-off contradicts the basic rule that shareholders should bear losses first and only then should creditors be called in. This is against the background that the shareholders received compensation, albeit small, as part of the takeover by UBS.
First considerations on the next steps
On 12 June 2023, the merger of Credit Suisse and UBS Group AG (UBS) was finalised. On 11 August 2023, UBS announced the termination of the federal loss protection guarantee and the end of the agreement between Credit Suisse and the SNB on liquidity assistance loans with federal default guarantee, following their full repayment. Switzerland had not been required to assume any losses so far. With the termination of these guarantees, the associated risks have ceased to apply for both Switzerland and the taxpayers.
In the course of the pending legal proceedings, it seems likely that the Federal Administrative Court would select one or several of the cases as “pilot cases”. Such an approach was already taken in similar situations in the past (eg, in the administrative assistance request by the US IRS and the related hundreds of cases). Such a pilot case is likely to be brought for review and final decision to the Federal Supreme Court. The resulting decision later serves as a precedent for all legal questions which are also posed in the other pending cases (eg, whether a viability event occurred, whether the investors could and/or should have known about the possible write-off). That way, when dealing with the other pending cases, only facts and circumstances peculiar to the specific case would have to be addressed specifically.
Should the Federal Administrative Court uphold FINMA’s order to write off all AT1, the complainants might consider seeking compensation, arguing that their investments were expropriated by FINMA. Determining the exact amount of compensation remains unclear given the volatility experienced by Credit Suisse’s AT1 leading up to the intense takeover weekend. On 17 March 2023, the last trading day before the transaction, some of the AT1 were traded at 23% of their nominal value. However, the Federal Administrative Court could also determine that no expropriation occurred and therefore no compensation is owed.
Conversely, if the Federal Administrative Court overturns the order to write off the bonds, they would – under the current understanding – regain validity. This would impose a USD16-billion debt on UBS. In such a scenario, UBS might consider turning to the government, depending on the assurances from both FINMA and the Department of Finance regarding the write-off as part of the transaction.