While filed lawsuits by bondholders over Credit Suisse’s emergency takeover are becoming increasingly menacing for Switzerland, the damage to investor confidence could be irreversible.
Switzerland is recognized for its legal certainty, which is why the shock sits all the deeper after the Swiss Financial Market Supervisory Authority (Finma) wrote off its AT1 instruments as part of the emergency rescue of Credit Suisse.
Finma justified this drastic step through the occurrence of a «trigger event,» allowing AT1 instruments to be written off in full by government intervention.
Questioning the Future
Following the decision by Swiss regulators, investors are now questioning the future of the $260 billion market for Tier 1 bank bonds.
Originally introduced in the aftermath of the global financial crisis, AT1 bonds are a class of debt securities designed to absorb losses when banks get into trouble.
Creditor Hierarchy
These securities are usually preferable to equity when a bank’s balance sheet undergoes a restructure. However, in the case of the Credit Suisse takeover, a total of 16 billion francs worth of AT1 Credit Suisse bonds were written down to zero, while shareholders are set to receive three billion francs from the sale of Credit Suisse to UBS.
The Swiss Federal Department of Finance has confirmed that it is already confronted with two so-called state liability requests and that it is aware of investors examining additional lawsuits connected to the takeover of Credit Suisse by UBS. Currently, a group of about 30 investors in Singapore, which includes individual investors and family offices, is seeking to sue the Swiss government over Credit Suisse's AT1 bond wipeout.
Sharp Sell-off of AT1 Bonds Worldwide
The looming lawsuits all depend on the courts finding out whether a better outcome would have been possible for bondholders. The European Central Bank and the Bank of England were quick to point out that in a similar situation, they would not touch the creditor hierarchy and would first ask shareholders to pay in full.
Finma's decision initially led to a sharp sell-off of AT1 bonds worldwide. In the meantime, however, statements by the Bank of England (BoE) and European Central Bank (ECB) have calmed the waters. However, a consequence of Finma’s actions has led to a loss of investor confidence and market experts considering imposing a so-called Swiss «legal risk premium.»
Long Aftermath
The dried-up AT1 market could push banks to improve their balance sheets by issuing more expensive shares or scaling back their businesses.
The aftermath of the AT1 crisis is therefore likely to last even longer in the financial sector. Yet, In Switzerland, it is clear that the damage to investor confidence could be irreversible.
