THE crisis that has engulfted Credit Suisse has unfolded rapidly, with the latest milestone being the dramatic decision to write down all of the bank’s Additional Tier-1 (AT-1) bonds. Our global team supports clients affected by the AT-1 bond writedown and we share some key takeaways from the latest developments.
Confusion around the bond’s identity
AT-1 bondholders have a legitimate expectation that their investment ranks above equity investors in the capital structure. Naturally the decision to write down AT-1 bonds to zero, while equity investors receive payouts as part of the UBS takeover, has left many investors frustrated and confused.
We see a unilateral decision to downgrade the priority of bondholders to below that of shareholders. This appears, at first instance, to be unfair as bondholders are not granted the powers and privileges that come with being a shareholder. Now 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 AT-1 bonds may be perceived to have departed from the legitimate expectations of the bondholders.
Several regulators in Europe have now publicly expressed that the rights of bondholders will be respected, that bondholders would bear losses only after shareholders’ equity has been depleted, in the hope that the Credit Suisse situation would be contained 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 AT-1 bonds would be written down.
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In the same vein, the Bank of England affirmed that AT-1 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.
License to write down, or not?
While there may be a contractual provision in the bond documentation that allows for the AT-1 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 AT-1 bonds, whether that power is absolute or comes with limits.
While this is plainly not a case in which 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 is an important principle under Swiss law.
A new law was introduced as late as Mar 19 to empower the Swiss regulator with unbridled discretion to write down AT-1 bonds. This may suggest that the clause in the contract itself was not sufficient.
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. In many ways there is little that investors could do to fend off this painful curveball.
With higher potential returns and higher risks, AT-1 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 AT-1 bonds would come undone when an enterprise fails, the soundness and stability of the enterprise are paramount. The attention of bondholders may turn to whether the management in Credit Suisse which made decisions leading to the crisis could be seen to be responsible for the current situation.
Who benefits from the crisis?
The objective reasons in support of the decision to write down the AT-1 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. After all, shareholders 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 writedown 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.
The writer is partner, dispute and resolution, Withersworldwide, Singapore. This article does not contain legal advice and should not be relied on as legal advice.
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