Efforts are gathering pace to challenge the decision by the Swiss regulators to pay Credit Suisse equity-holders CHF3 billion whilst writing down the value of AT1 debt-holders to zero.
The write-down, announced the evening of 19 March before markets opened on Monday morning, has decimated the $250 billion AT1 bond market in Europe, with a cataclysmic impact on both market pricing and market liquidity. But with these instruments being held not only by hedge funds and institutional investors, but also distributed to smaller and retail investors, both Swiss and overseas, many players are now calling for urgent redress.
Over 600 people joined a webinar on Wednesday hosted by Quinn Emanuel, “the most feared law firm in the world” (and one with a history of litigation against Credit Suisse), to explore their options with regards to litigation claims against both the bank as an issuer, and Switzerland as the enactor, of the recent AT1 bond write-down.
Changing lanes
The crux of the challenge would appear to be the special ordinance passed by the Swiss government on 16 March, prior to the merger being made official and without any announcement to investors or the public, which gave FINMA the authority to ignore the established enforcement of loss hierarchy in the event of a write-down.
The emergency decree created a new law to enable the terms of the merger transaction (including the waiving of shareholder approval and the decision to place equity obligations above the rights of junior creditors) because under the existing ‘too big to fail’ Swiss legislation, it appears the deal in its current form may not have been possible.
Article 19 of the Swiss Capital Adequacy Ordinance states that: “Common Equity Tier 1 capital shall absorb losses before the Additional Tier 1 capital,” and that: “Additional Tier 1 capital shall absorb losses before Tier 2 capital.” It also clarifies that: “Should individual instruments of the same capital component (outside CET1) absorb losses differently, the bank must specify this in its articles of incorporation or at issue of the instrument.
The new ordinance allowing FINMA to sidestep the established loss hierarchy is believed to have been adopted partly on 16 March and partly on 19 March, but was only made public on 19 March – crucially, after the merger was announced, and after the bond write-down was confirmed, the timing of which could become a key element in any court case.
In addition, in the AT1 documentation for the bonds themselves, the law firm suggested that the definition of a ‘write-down’ event could also be challenged: as the requirements would seem to indicate that the bank had to be in danger of insolvency in order to trigger a write-down to zero (along with other factors).
The fact that other regulators, including the European Central Bank (ECB) and the Bank of England, immediately distanced themselves from the Swiss decision and reaffirmed their commitment to the standard hierarchy for bank funding also indicates, said Quin Emanuel, that there could be international support for a challenge to Swiss law. So what avenues are available to investors?
What can be done?
One possibility mooted in the Quinn Emanuel webinar could be a legal challenge brought in Switzerland against the issuer (Credit Suisse) for mis-selling. Based on the bank’s fixed income investor presentation of 14 March 2023 in which it stated that its capital adequacy situation was sound and that liquidity issues had been addressed. Given that the bank did not disclose any issues that could have warned the market about adverse conditions, there could, suggested the firm, be a case to argue that any bonds traded/purchased in the period between 14 March and 19 March were based on inaccurate statements by Credit Suisse. The key point here would be the issue of market expectations regarding the terms of the prospectus versus the risk of ad hoc legislation: did Credit Suisse know about the new ordinance on 16 March and if so, were they under an obligation to inform their investors/bondholders of the possibility?
Another avenue could be a claim against Switzerland itself – either the government and/or the regulatory agencies, notably FINMA. Any challenge to FINMA’s decision would need to be addressed in court within 30 days of the FINMA order, with Quin Emanuel suggesting that a challenge could be made on the basis of a violation of property rights and arbitrary exercise of discretion.
The constitutionality of the 16 March special ordinance could also be challenged – and here, it would seem that the wheels may already in motion. The Swiss Parliament is apparently (said Quinn Emanuel) convening an extraordinary assembly, beginning 12 April, after Swiss government representatives demanded to discuss the emergency decree.
“Apparently the government can’t just introduce new laws,” said one lawyer. “There is uproar in Switzerland right now, with people asking why they had a superb ‘too big to fail’ regulation for 10 years that everyone planned against, which was thrown away overnight to be replaced by a new regulation that took away rights and breached standard hierarchy. There is a lot of potential here for litigation, but there is also the option for political redress.”
Other options are to take action against Switzerland in other countries, potentially based on bilateral investment treaties (BITs) – of which Switzerland has many, designed to protect the rights of foreign investments in the host country. Non-Swiss AT1 bondholders could plausibly base action on these, although they would have to be based in jurisdictions with Swiss BITs: such as Singapore, Hong Kong, the UAE, Saudi Arabia and Qatar.
Swiss treaties – including BITs – usually contain requirements that any expropriation, nationalisation or “measures tantamount to expropriation” cannot be effected without compensation. The devaluation of AT1 bonds could potentially be viewed as a government measure of expropriation, suggested Quinn Emanuel, thus triggering an obligation to compensate bondholders. BITs require “fair and equitable” treatment of foreign investors, and also usually include a requirement to provide procedural fairness and transparency, which could be argued to include the honouring of legitimate expectations about the state’s laws that an investor reasonably had when making the investment. The emergency law passed to legalise the write-down could potentially, the law firm noted, be seen as a breach of that fair and equitable treatment standard: a challenge that could stand independently or in conjunction with an expropriation claim.
There is some potential to make a claim in the US under either Federal or state securities law (such as California’s popular ‘blue-sky’ law). However, this would be more difficult – first, the Credit Suisse AT1 bonds were predominantly sold to US investors using the 144A exemption, meaning that they are exempt from registration with the SEC. That doesn’t mean the seller is immune to liability – claims can be brought under Rule 10b-5 if the plaintiff can prove that the seller knowingly made a misrepresentation that cause economic loss – but Credit Suisse would almost certainly argue that they didn’t know at the time of sale and therefore could not be liable for fraud. So although it would potentially be possible to bring a challenge in the US, in Quinn Emanuel’s opinion “these claims would face very serious challenges”.
Urgent action, swift recovery
Either way, the clock is ticking and investors will have to make some quick decisions on which path they choose to take. “We essentially have a 30-day window,” concluded a Quinn Emanuel lawyer. “There is a strong argument to get arguments together and get letters out quickly.”
With multiple law firms currently pitching for work in the litigation stakes, it’s therefore likely that we could see some rapid movement – and this hope of redress has already worked some magic in the trading stakes.
“After an initial selloff, the AT1 bond market has recovered somewhat from the shock of the Credit Suisse write-down,” said Paul Summer, head of structured notes and financials trading at fixed income investment bank KNG Securities. “The affected Credit Suisse AT1 bonds are now trading at around 5% of notional value, as some investors see hope of a legal challenge.”
Notably the Credit Suisse Tier 2 bond 6.5% 08/08/23 (which was not written down even though it included bail-in language) dropped to 60% but is now trading above 90%.
Read More – Lone CoCo bond escapes the Credit Suisse carnage
“Investors in other AT1 bonds were comforted by comments from the EU and UK authorities that they would expect common equity instruments to absorb losses before AT1 is written down,” added Summer.
“However, in our view, this will permanently affect the AT1 market, with investors having to pay much more attention to the terms and conditions of future new issues, and consequently demanding a higher interest premium.”
The ripple effect
And at the risk of being pessimistic, it’s not just the bond write-down that could cause a legal headache in the coming months.
“When deposits are volatile and market confidence is uncertain, focus increases on banks’ tightening liquidity. When liquidity tightens, we can expect to see an uptick in claims between banks and their customers and counterparties,” warned Charlotte Henschen, a partner in the commercial and banking litigation team at international law firm RPC.
After the global financial crisis, for example, banks faced a tidal wave of litigation for mistreating customers. When times get tough, banks tend to get tougher – which can, suggested Henschel, result in actions which amount to a breach of their agreements with their clients as they seek to protect their own interests.
“Litigation could arise from disputed margin calls, where customers consider that a margin call was invalid or unjustified, the parties dispute the valuation of the collateral posted,” she noted.
“Banks may also be taking a close look at their exposure to customers and the adequacy of the security which they have in place. This may result in litigation where the parties disagree as to the valuation of such security, with arguments as to whether such valuations were previously inflated artificially.”