How Credit Suisse's CoCos could rise from the dead

By Liam Proud

There's a zombie lurking in bank credit markets, and it could in theory bite the Swiss government and UBS UBSG. In March 2023 the pair jointly agreed an emergency rescue of Credit Suisse, which involved cancelling "contingent convertible" securities to the tune of 16.5 billion Swiss francs, or $17.8 billion using contemporary exchange rates. On Tuesday, a Swiss court ruled the write-off unlawful. The country's Supreme Court will ultimately decide what happens next, but few of the plausible scenarios look pretty for Swiss Finance Minister Karin Keller-Sutter and UBS Chair Colm Kelleher.

Writing off Credit Suisse's CoCos, also known as additional Tier 1 (AT1) debt, created a slug of equity for UBS. That allowed it to absorb asset markdowns and legal charges during the integration. The decision, taken by Swiss regulator FINMA, was controversial. Aggrieved AT1 holders, with help from law firm Quinn Emanuel, argued that the legal condition for cancelling the securities was not met. On Tuesday the Federal Administrative Court agreed, stating in a judgment that the "contractual viability event" was not triggered: Credit Suisse was well capitalised when FINMA imposed the write-off. Traded claims on the defunct instruments surged to a third of face value, in expectation of compensation.

What happens next is unclear. That's partly because FINMA is appealing the decision, meaning the Swiss Supreme Court will ultimately decide. It's also because the lower court shelved the topic of compensation. That involves thorny questions like how much the AT1 investors should get, who should cough up, and whether holders who didn't sue should get paid. There are at least three possible answers, according to a person familiar with the case.

First, Credit Suisse's AT1s could simply be reinstated. That would mean no one has to fork out any compensation, though unwinding the 2023 write-off could potentially force UBS to raise capital. One obstacle is that the securities don't really exist any more.

Second, the court could order the government to compensate investors in cash. One debate would be whether AT1 holders should get back anything close to face value, which might seem odd since the market value of bonds was tumbling in March 2023. This scenario would also be bad for UBS, indirectly, because politicians might feel like the government was belatedly picking up the tab for the rescue deal. That would be awkward amid a tense capital-rule standoff.

Third, the court could follow the precedent of a recent case involving Credit Suisse bankers stripped of their bonuses, who won their own legal victory this year. The government is also appealing that decision, which if upheld could see UBS having to pay 62 million Swiss francs of restored bonuses. A repeat with the AT1 case would put UBS on the hook to cover the investors' losses.

That would seem perverse, since FINMA and the government made the write-off decision, not UBS. And none of this will happen if the government wins on appeal. Yet the Supreme Court usually concurs with the administrative court, figures in the latter's annual report show. In other words, the AT1 zombie could rise again.

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CONTEXT NEWS

Swiss market regulator FINMA said on October 15 that it would appeal a ruling by a Swiss court that revoked a decree by the financial watchdog ordering the write-off of Credit Suisse debt during the bank's collapse in 2023.

The Federal Administrative Court said on October 15 that the writing off of 16.5 billion Swiss francs ($20.69 billion) in Credit Suisse Additional Tier 1 (AT1) bonds was unlawful, boosting bondholders' hopes of recouping losses and raising fresh questions about how authorities handled the bank's demise.