The banking crisis from across the world is unfolding rapidly, with the latest milestone being the dramatic decision to write down millions from Credit Suisse AT1 bonds. Withers has a global team to support clients affected by the AT1 bond crisis and we share some key takeaways from the latest developments.
Confusion around the bond's identity
AT1 bondholders have a legitimate expectation that their investment ranks above in priority of equity investors, and so naturally the decision to write down AT1 bonds to zero while having equity investors receive payouts as part of the UBS takeover has left many investors frustrated and confused.
We see a unilateral decision taken to downgrade the priority of bondholders to rank below that of shareholders. This would, at first instance, appear to be unfair as bondholders are not granted the powers and privileges that come with being a shareholder; now the shareholders enjoy the benefits but not the attendant risks, with such risks borne by bondholders instead.
Accordingly, the move by the Swiss regulator to write down AT1 bonds may be perceived to have departed from the legitimate expectations of the bondholders, as we can see that several regulators in Europe are now publicly expressing a sentiment that the rights of bondholders will be respected and would bear losses only after shareholders' equity have been depleted, in the hope to contain the Credit Suisse situation as a 'one off' incident.
In particular, the European Central Bank and the European Banking Authority affirmed publicly that equity instruments would be the first to absorb losses before any AT1 bonds would be written down. In the same vein, the Bank of England affirmed that AT1 bonds rank above equity investment. This accepted practice in Europe in many ways affirms the legitimate expectations of bondholders, and raises the question of whether the Swiss regulator has acted inconsistently with market expectations.
See also: MAS fines Credit Suisse $3.9 mil for misconduct by its relationship managers
License to write down, or not?
While there may be a contractual provision in the bond documentation that allows for the AT1 bonds to be written down, the law could in some instances imply or read provisions into the contract. It remains to be seen, even if there is indeed the contractual power to write down AT1 bonds, whether that power is absolute or comes with limits. While this is plainly not the case where the wheel of fortune was spun to see where the arrow lands, investors may consider that any discretion would be exercised in good faith to protect bondholders' reasonable and fair expectations. This is particularly so if any mandatory laws applied in the circumstances, as the doctrine of good faith an important principle under Swiss law.
Reportedly, a new law was introduced as late as Sunday, 19 March 2023 to empower the Swiss regulator with unbridled discretion to write down AT1 bonds. This may suggest that the clause in the contract itself was not sufficient.
See also: Credit Suisse's Singapore private bankers moving to UBS offices
A black swan within a black swan event
The domino effect from the collapse of Silicon Valley Bank has now led to this controversial and arguably unforeseen decision to pervert the usual course of priority, and so in many ways there is little that investors could fend against this painful curveball. With higher potential returns and higher risks, AT1 bonds are designed to privatise losses as a way to allocate risks to private investors and to mitigate the public costs of a bailout.
Given that AT1 bonds would come undone when an enterprise fails, the soundness and stability of the enterprise is paramount. The attention of bondholders may turn to whether the management in Credit Suisse who made decisions leading to the crisis could be seen to be responsible for the current situation.
Who benefits from a crisis?
The objective reasons supporting the decision to write down AT1 bonds are still being considered. Questions are now being asked around whether and to what extent the decision was influenced by the shareholders, with some considering if there was political motivation behind the decision to safeguard equity before AT1 bondholders, for after all, it is the shareholders who benefit from this development.
Legal recourse
Affected bondholders would do well to consider the applicable dispute resolution options arising from the situation, with reference to the relevant provisions in their bond documentation. It would be important to develop a coherent cross-border legal strategy in light of the international elements around the crisis.
Across the world, we can expect investors to challenge the write down via cross-border litigation, confidential international arbitration and/or private international mediation, via claims such as breaches of contract and economic torts including unlawful conspiracy to interfere with economic rights.
Shaun Leong, Chris LaVigne and Hussein Haeri are partners with Withersworldwide.
