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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is a managing partner and head of research at Axiom Alternative Investments
The AT1 bond market does not have many friends. When Swiss authorities controversially wiped out $17bn of the Additional Tier 1 bonds issued by Credit Suisse, many claimed that the market was dead. As the argument went: “Surely no one would be foolish enough to read the terms and conditions and still buy bonds that can be worth zero overnight?”
Lots of people were, it turned out: since lows hit in the wake of the failure of Credit Suisse, a Bloomberg index of the price of the bonds is up 50 per cent. And 2024 still saw a near 60 per cent increase in issuance to €46bn, according to Barclays. This year issuance has reached €34bn.
AT1s were introduced as a form of supplementary bank capital, designed to be wiped out in a crisis to cover losses. They are crucial to reduce bank’s cost of equity and increase their capacity to lend. The issue with the Credit Suisse AT1s is whether the bonds were wiped out fairly.
The Swiss Federal Court ruled on Tuesday that the treatment of the bonds was unlawful — a decision my investment firm supports as we own some bonds affected and are taking separate legal action. Now we are hearing a similar argument to the one made at the time of the Credit Suisse failure, only in reverse: if you cannot wipe out AT1 capital when an entity is a “gone concern”, the asset class is dead.
But the circumstances of the Credit Suisse saga are idiosyncratic. To simplify, Swiss regulator Finma argued that it had basically three grounds to wipe out the bonds: two contractual grounds based on the terms of the bonds, and one general legal right, as an authority overseeing the bank’s resolution.
The court dismissed the contractual grounds with a reasoning that is strictly limited to the specifics of this case. The terms and conditions allowed the wipeout in two situations: i) a notification by Finma of the non-viability of the bank and request by it for the wipeout of both AT1 and Tier 2 bonds or ii) necessary state aid improving the capital of the bank. On the first point, the court noted that Finma issued no such notification and, incomprehensibly, did not wipe out Tier 2 bonds. It could have done so. On the second point, the court says that Credit Suisse only received liquidity, and liquidity does not improve capital.
The last nail in the coffin? Finma argued that, as AT1 eligible bonds, the terms were maybe unclear but should have allowed the wipeout. The court answered that Finma should not have authorised the bonds if they did not meet AT1 requirements.
The discussion on the “general legal right” is also very intriguing. There were many ways for the Swiss authorities to zero the bonds. Swiss banking law gives huge discretion to Finma as a resolution authority and the court points that it explicitly refused to declare a resolution event and wipe out the bonds, presumably to protect the shareholders who received $3.2bn from UBS in the takeover of Credit Suisse and would have been left with nothing in a resolution. Under the Swiss constitution, an infringement on property rights requires a law and emergency ordinances can only be used as a substitute if no law is readily available.
None of this has direct implications for the rest of Europe. European authorities have already proved that swift and strict application of resolution laws can be done with little litigation risk. Sberbank Europe was wound down in 2022 and even the fall of Banco Popular in 2017 did not leave many pathways for AT1 bondholders to pursue redress in court.
Where does this leave UBS? Our firm has an interest in the outcome as we own UBS bonds but hold short positions on the stock. It’s the big unknown, and the Swiss court was very careful to point out that it was not answering that question — yet. This is why it calls its own decision “partial”. But the full text of the ruling hints at three possibilities.
Ruling that the ordinance wiping out the bonds is null could simply mean that the bonds are reinstated and reintroduced in UBS’s balance sheet. Whether UBS could receive indemnification from the Swiss government, in the middle of the current tense discussion on massive new capital requirements for the bank is another story. But the court could also rule that the AT1s remain void and that its decision only opens the right to seek indemnification from Finma or from the now combined Credit Suisse-UBS.
Who pays what in that scenario remains highly speculative — not to mention that this complex decision is not final and Finma will appeal against it. The Credit Suisse AT1 saga is far from over.