Swiss regulator defends $17bn wipeout of AT1 bonds in Credit Suisse deal

Swiss financial regulator Finma has defended its decision to wipe out a huge swath of risky subordinated bonds as part of the Credit Suisse rescue deal.

The move taken on Sunday, which rendered SFr16bn ($17bn) of investments worthless, has become one of the most controversial elements of the shotgun marriage between Credit Suisse and its larger rival, UBS, brokered by Swiss authorities.

Just hours after the deal was announced, other large market regulators began to distance themselves from the decision, fearful that it would endanger banks’ ability to raise capital in the future.

Enraged bondholders have pledged to sue the Swiss government and Finma over the matter.

In its first statement on the deal since the weekend, Finma said on Thursday that all the contractual and legal obligations had been met for it to act unilaterally given the urgency of the situation.

“On Sunday, a solution was found to protect clients, the financial centre and the markets,” said Finma’s chief executive Urban Angehrn. “In this context, it is important that Credit Suisse’s banking business continues to function smoothly and without interruption.”

Speaking to the press on Thursday, Swiss National Bank chair Thomas Jordan argued that the purchase by UBS had been the only option for Credit Suisse, saying that a takeover of the bank by the government and stabilisation of it in a process known as resolution would have risked a systemic crisis.

“Resolution in theory is possible under normal circumstances, but we were in an extremely fragile environment with enormous nervousness in financial markets in general,” said Jordan. “Resolution in those circumstances would have triggered a bigger financial crisis, not just in Switzerland but globally.”

“[It] would not have worked to stabilise the situation but, on the contrary, created enormous uncertainty . . . It was clear that we should avoid it if there was any other possibility.”

At the crux of the controversy was the regulator’s decision — taken in conjunction with the SNB and Swiss ministry of finance — to preserve some value for Credit Suisse shareholders, who would nominally be subordinated to any bondholders in the capital structure.

UBS will pay SFr3.25bn for Credit Suisse’s shares.

The additional tier 1 (AT1) bonds in question contained explicit contractual language that they would be “completely written down in a ‘viability event’ in particular if extraordinary government support is granted”, Finma said. This allowed the regulator to prioritise equity holders ahead of AT1 holders.

AT1s are a type of hybrid debt instrument created after the financial crash of 2008 to give banks greater capital flexibility in the event of crises.

As part of the acquisition deal by UBS, the combined bank will receive SFr9bn of government guarantees and a SFr100bn liquidity lifeline from the SNB.

An additional emergency government ordinance issued by Bern on Sunday had further confirmed the power to take decisions over elements of a bank’s capital structure in Swiss law, Finma said.

“[The] instruments in Switzerland are designed in such a way that they are written down or converted into [equity] before the equity capital of the bank concerned is completely used up or written down,” it said, pointing out that the bonds were designed for the use of sophisticated institutional investors because of their risky hybrid nature.

Quinn Emanuel Urquhart & Sullivan and Pallas Partners are among the law firms representing bondholders that have pledged to fight the Swiss decision.

Quinn hosted a call on Wednesday joined by more than 750 participants.

Partner Richard East told the Financial Times the deal was “a resolution dressed up as a merger” and pointed to statements by the European Central Bank and the Bank of England, which distanced themselves from the Swiss approach.

“You know something has gone wrong when other regulators come and politely point out that in a resolution [they] would have respected ordinary priorities,” he said.